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What Is Ad Valorem Tax?

This tax rises along with property value.

[Updated: Feb 04, 2021 ] Jun 10, 2020 by Matthew DiLallo
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Governments at every level levy a variety of taxes to generate revenue. They also use a multitude of methods to calculate these taxes. One of the means that taxing authorities use is to base the tax on the value of an item. These taxes are known as "ad valorem" taxes, which comes from the Latin words meaning "according to the value."

What is ad valorem tax, and how is it used in real estate?

Ad valorem taxes are common in real estate. Local government agencies tax real property in several different ways based on the value of the property. These ad valorem real estate taxes include:

  • Transfer taxes as part of the closing costs in a real estate transaction. Taxing authorities levy this tax based on the sale price of a property.
  • Annual real property taxes. Taxing agencies base these taxes on the assessed value of the property.
  • Capital gains taxes on the sale of real estate. Taxing authorities will levy this tax based on the increase in the property's value upon its sale.

What types of property does the ad valorem tax apply to?

Governments levy taxes on all types of property, including real property (real estate) and personal property (both tangible and intangible). Ad valorem taxes are common with real estate as local taxing authorities (such as county and municipal governments as well as the school districts) levy an annual tax based on the assessed value of the real estate in their jurisdiction. Meanwhile, most state governments collect ad valorem tax on tangible personal property, most commonly on motor vehicles and business personal property.

How is ad valorem tax calculated?

Taxing authorities levy taxes on real and personal property based on its value. For real estate, levying bodies use the assessed value, which attempts to gauge its fair market value. For tangible personal property, taxing authorities often use the estimated depreciated value of an item.

Once the taxing authority determines the taxable value of an item, it can use that to collect an ad valorem property tax. For example, suppose the local tax collector has assessed a property at $250,000. The agency charges an annual millage rate of 1% based on the assessed value. Thus, the owners of this real estate would receive a property tax bill for $2,500.

What are the factors that determine the value of ad valorem tax?

Taxing authorities base ad valorem taxes on the assessed value of a property. These government agencies will employ a property appraiser to determine a property's assessment value. They'll look at several things to establish this estimate, including:

  • The recent sales price of similar properties in the area.
  • The value of any recent improvements.
  • Any income generated by the property (such as renting out a room).
  • The replacement cost.

Because real property owners pay taxes based on the assessed value, they'll want to make sure the assessor isn't overvaluing their property. If a real estate owner believes the assessed valuation is too high, they can appeal their property taxes by requesting a reassessment, which is a second evaluation of a property's value. Winning a reassessment can potentially save a property owner lots of money in annual real estate taxes.

It's important to know your tax value

Because ad valorem taxation is on assessed value, property owners need to ensure that taxing authorities have that number right. If they assess the value of a property above the price it would likely sell for on the open market, then the current owner will pay more in taxes than they should. Because of that, property owners need to keep an eye on the assessed valuation and fight that number if it's too high since that could reduce their tax bill.

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