Understanding the Most Common Real Estate Tax Codes and Their Uses
Real estate taxes, commonly known as property taxes, are a significant source of revenue for local governments in the United States. These taxes are based on the assessed value of real property, including land and the structures on it. In the U.S., various tax codes govern how real estate taxes are levied, who qualifies for exemptions, and how these funds are used. Below are some of the most common real estate tax codes, their implications, and potential future changes.
- The General Property Tax Code
The General Property Tax Code is a comprehensive set of laws that governs how property taxes are assessed and collected at the local level. These codes may vary somewhat from state to state, but most share a few common features:
- Assessment: The property tax process begins with an assessment of the property’s value, typically performed by a local tax assessor. The assessed value is based on the property’s market value or a percentage thereof, depending on the state’s specific rules.
- Millage Rate: Once the property’s value is assessed, the local government applies a tax rate, often expressed in mills (one mill equals 1/1000 of a dollar). The millage rate is typically set by local school boards, city councils, and other municipal governing bodies.
- Collection: Once assessed, the tax becomes a lien on the property, meaning that the tax must be paid before the property can be sold. Property tax bills are generally sent on an annual or semi-annual basis.
- Mortgage Interest Deduction (IRC Section 163)
The mortgage interest deduction is a significant component of the U.S. tax code that directly impacts real estate owners. Under Section 163 of the Internal Revenue Code, homeowners can deduct interest paid on mortgage debt of up to $750,000 ($375,000 if married filing separately). This deduction can make homeownership more affordable by reducing the after-tax cost of mortgage interest.
- Property Tax Deduction (IRC Section 164)
Homeowners may also deduct property taxes paid to local and state governments under Section 164. However, as part of the Tax Cuts and Jobs Act of 2017, the total deduction for state and local taxes (including property taxes and either income or sales taxes) is capped at $10,000.
- Capital Gains Exclusion on the Sale of a Residence (IRC Section 121)
Under Section 121, homeowners can exclude up to $250,000 ($500,000 for married couples filing jointly) of gain from the sale of a primary residence if they have owned and lived in the home for at least two out of the last five years before the sale. This tax break can be a significant benefit for homeowners when they sell their homes.
- Depreciation (IRC Section 168)
For rental property owners, Section 168 allows for the deduction of the cost of the property over its useful life, defined as 27.5 years for residential real property. This depreciation deduction can offset rental income, potentially reducing the owner’s tax liability.
The Future of Real Estate Taxes
The future of real estate taxes in the U.S. is likely to be influenced by ongoing discussions about tax reform at both the federal and state levels. Some key trends to watch include:
- Caps on State and Local Tax (SALT) Deductions
The cap on SALT deductions enacted as part of the Tax Cuts and Jobs Act of 2017 has been a contentious issue, particularly in high-tax states. There has been ongoing debate about whether this cap should be lifted, which could have significant implications for the effective tax rates of homeowners in those states.
- Changes to Capital Gains Exclusions
There has been some discussion about potential changes to the capital gains exclusion for primary residences, including increasing the ownership and use requirements or limiting the ability of high-income taxpayers to claim the exclusion. However, as of my knowledge cutoff in September 2021, no changes have been enacted.
- Property Tax Limitations
At the state and local level, there may be continued debates about property tax limitations, or caps, which limit the rate at which property taxes can increase year over year. These caps can help keep property taxes affordable for homeowners, but they can also strain local budgets.
- Climate Change and Property Taxes
The impacts of climate change on property values, and consequently property tax revenues, are likely to be a growing concern in the coming years. Coastal areas at risk from sea-level rise, in particular, may see significant shifts in property values.
In conclusion, real estate tax codes play a significant role in the economics of owning, buying, and selling property. Keeping up with changes in these codes is critical for homeowners, potential buyers, and real estate professionals alike. With potential tax reforms on the horizon, it’s an area to watch closely in the coming years.
