Tuesday, February 2, 2016

Detailed Property Tax Calculation Example

Provo Mormon Temple

Part 8 of the pro forma building series discussed the basics of calculating property taxes. Unfortunately, calculating the property tax expense can get substantially more complicated, unless Carly Fiorina can somehow become president and reduce the tax code to 3 pages, but judging by her performance in Iowa, I wouldn't hold my breath on that one. This post will assume Carly doesn't become president and go over some of the nuances in the property tax calculation.

Assessed Value Complications

As we discussed in the previous post, property taxes are calculated based on the assessed value of the property and the millage rate. That fact is constant, but understanding the assessed value can get a bit tricky in some cases.

For example, in some states, like Maryland, when a property is purchased the assessed value doesn't immediately become the purchase price. Instead, the assessed value increases in equal increments from its current value to the purchase price over 3 years (could be plus or minus 1, not exactly sure). If a property at the time of sale has an assessed value of 10M and is purchased for 13M, then year 1 assessed value will be 11M, year 2 will be 12M, and year 3 will be 13M.

In Texas, every couple of years the county looks at the state of the commercial real estate market and assigns a new assessed value to properties. Transfer of ownership of a property will likely have little to no effect on the assessed value of the property.

As you can see, there are many little wrinkles in how the assessed value is actually calculated in different states. When acquiring a property it's imperative to understand how the assessed value of the property is affected by the acquisition so you can accurately forecast the property tax expense.

One last note is that when properties are reassessed can vary between states as well. In California, counties are often slow to reassess a property after a purchase. You could buy a property and a year or two later the county still hasn't changed the assessed value to reflect the purchase price. Just something to keep in mind and also try to get a grasp on when acquiring a property.

Capital Improvements Triggering Reassessments

Capital improvements, much like transfer of ownership, can trigger a reassessment. So what exactly is a capital improvement? Capital improvements are changes to a building that improve it beyond its current state. They differ from repairs and maintenance because they are meant to keep the property in its current condition. An example of a capital improvement would be refinishing the exterior of a building. They could also be replacing the HVAC systems, adding fire sprinkler systems, or adding an elevator system to a building.

These capital improvements are, in theory, adding value to the building at least dollar for dollar (hopefully more if you know what you're doing). That's exactly how counties look at it as well and, subsequently, capital improvements increase the assessed value of a property. How exactly do counties find out about them? Well, if the work is substantial, then permits need to be pulled and that process can potentially trigger the reassessment. An example would be if I purchase a building for 10M and plan on 5M worth of capital improvements spread out over 2 years. In year 1, assuming I've completed 2.5M worth of improvements, the assessed value will become 12.5M. In year 2, assuming another 2.5M worth of improvements have finished, the assessed value will become 15M.

Comprehensive Property Tax Calculation Example

Here's a spreadsheet with a comprehensive property tax calculation: example. The idea is that, year 1, the county is behind on adding capital improvements to the actual assessed value. In year 2, the county adds year 1's capital improvements to the assessed value, but, again, they are behind on adding year 2's. The same principle applies to year 3 and 4.

Also note that I'm concurrently calculating what the assessed value would be if the purchase price were just grown 2% annually. For the sake of being conservative, I'm assuming the county will make the assessed value the greater of the purchase price plus capital improvements, or the initial purchase price grown 2% annually.

Hopefully this explanation brought greater clarification to a surprisingly difficult calculation. The trick is getting on the phone with someone from the county you're acquiring a property in and hearing it directly from the horse's mouth how they assess the property's value.

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