The following was written by Steve Nowak, an Ohio-based attorney specializing in real estate taxes.
If you have questions about your specific situation, contact your tax or financial professional or your state taxing authority.
Real estate taxes are one of the oldest taxes in America and can be a significant expense for real estate investors. Local governments set real estate values for those parcels of real estate within their jurisdiction. The real estate tax often provides a significant source of revenue to our local governments. In Ohio, for instance, schools receive approximately 60 to 70 percent of billed and collected real estate taxes. Assessors tax residential real estate at different amounts than commercial real estate. Farm or agriculture real estate can also be taxed at different rates.
Your local government or taxing authority sets a tax rate and applies that rate to the assessed value.
Here’s the basic formula used to create a tax bill:
Value × Tax Rate = Tax Bill
Of course, the property owner is ultimately responsible for paying that tax bill. Given this obligation, the state and local governmental bodies provide a process that allows taxpayers and property owners to challenge the valuation of their real estate if the property owner believes it to be excessive.
In short, an overvalued property requires the payment of an excessive and unfair tax bill. In that situation, you may want to consider challenging that value with the appropriate governmental body.
Have You Challenged Your Property Valuation Lately?
If you have not challenged your real estate valuation for several years, you might be missing out on an opportunity. As an investor, you know markets change. If you successfully challenge an excessive valuation, you could cut your operating costs and increase your return on the investment you are holding in your self-directed IRA. Of course, this also applies to real estate not held within an IRA.
How is Value Determined?
An assessor typically seeks to value real estate at its “fair market value.” The “fair market value” is usually held to be that price at which the real estate would sell for in an open-market transaction, where both the buyer and seller act freely. As mentioned above, tax rates can vary from community to community. If you don’t know, check with the assessor where your real estate investment property is located to find the real property tax rate.
Is Your Property Overvalued?
If you have recently purchased property or you have a recent appraisal, determining the reasonableness of the assessor’s value is straightforward. If the sale price or the appraised value is lower than the valuation, you have a good indication that you should consider filing a valuation challenge (i.e., complaint or appeal). If you have not recently purchased your real estate, and you do not have a recent appraisal, then look at the assessor’s website. You may want to ask yourself does this value seem in line with recent local property sales?
Whether you feel strongly that the value is high or low or about right, you may want to consider talking with a real estate professional. As with most things, it’s best to consult an expert. Contact a trusted and knowledgeable real estate agent, appraiser, or real estate broker. Ask their opinion of an expected sale price for the property and/or a comparative market analysis for three or four comparable sales. Ask an appraiser if he/she feels the value falls within a range of reasonableness. Be careful to know your assessor’s date of valuation and make sure the person you consult is also aware.
If you are looking at residential rental property, consider other recent, arm’s-length sales of similar properties in the same area as the property in question. There are three methods of arriving at a value to consider: (1) the cost approach, (2) the sales comparison approach, and (3) the income capitalization approach.
The first two methods are relatively straightforward. The cost approach estimates what it would cost to build the property today and then deducts the obsolescence and depreciation from that amount to get to an estimate or opinion of value. The Sales Comparison Approach looks at other comparable sales in the same marketplace and makes adjustments based on the differences between the “comp” and the subject property to arrive at an informed and well-supported opinion of value.
The last approach is the Income Capitalization Approach, which considers actual income and expenses of the property against what one should expect from the “market.” After considering market rents, vacancies, and expenses, this method arrives at a net operating income (i.e., the “NOI”). This approach develops a value after applying a market-based capitalization rate is applied to the NOI. For instance:
$24,000 NOI ÷ 12.1% capitalization rate = $198,347 dollars, say $198,000 rounded.
Unless your investment property is five to seven years old or less or unique (i.e., a special use property such as a casino, car wash, water park, etc.), the Cost Approach may not be very reliable. Think about it—no investor buys a duplex based on what it would cost to construct a new, depreciated version of that duplex.
Each approach requires reliable data, familiarity with the property type, familiarity with the market, and a thorough understanding of the different valuation techniques. Again, consult with a professional who is both knowledgeable about your market area and your property type.
Who Can File a Tax Valuation Challenge?
Each jurisdiction will have its own rules and laws on this point. Typically, the person or entity challenging a value are (1) property owners, (2) a trustee of land held in a trust, (3) a court-appointed receiver, or a (4) school board. Again, this varies from state to state. If you decide to file a complaint, make sure you have the authority to do so.
You Have Decided to File a Valuation Complaint. What’s the Next Step?
Research the method and procedures your taxing authority provides. There are a lot of resources available to the public. Your local assessor’s website is a great place to start. If your assessor’s website is not helpful, consider reviewing a different assessor’s market. For example, your county may be rural and have only 10,000 citizens while the capital may have one million or more. These two jurisdictions have very different resources. Therefore, one assessor’s website might be more helpful than the others. Review more than one website. Read more than one article. Do your homework. I would also suggest contacting an attorney or tax professional at this point.
The process of challenging an assessed value may appear straightforward, but the devil is in the details. Remember, tax assessors are not in the business of returning money that has already been collected, spent, or allocated for important and vital uses.
What to Expect From the Challenge Process?
Generally speaking, the assessor receives your complaint or appeal and then sets a date, time, and location for a hearing. At the hearing, the person alleging the assessor’s value is incorrect presents evidence that the assessor’s value is too high or too low. After the hearing, which can vary greatly in formality, the board or entity hearing your complaint issues a decision. Some jurisdictions issue short, straight-to-the-point decisions. Some decisions can be pages long. If you do not agree with the decision, you may have a right to an appeal. Depending on your jurisdiction, that review can be before a court or another administrative agency.
If you file an appeal, make sure you follow the jurisdiction’s rules and procedures to the letter.
After you appeal, you can expect another hearing. You need to present the best evidence of value available. Almost always, the best evidence of real estate’s fair market value is a recent, arm’s-length sale or a properly prepared appraisal report’s opinion of value. You can expect this hearing to be more formal than your first.
The court or administrative body hearing the appeal will then issue its own decision. Again, some jurisdictions issue a lengthy decision with findings of fact and conclusions of law while others write very short decisions. Again, if you do not agree with the decision, you likely have appeal rights. If, at this point in time, you are still doing this yourself, contact an experienced professional who is familiar with how this process works in your jurisdiction. At this point in the process, your options could be very limited.
Should You Do It Yourself?
Every sophisticated property owner should be able to handle their own valuation challenge just like every sophisticated taxpayer should be able to file their own tax returns. That being said, sometimes it is just not worth the time or the risk of doing it yourself. If you are a full-time investor you know the value of your time and respect contractor’s and professionals’ expertise. Think about home improvement projects. I have learned (more than once) not to touch anything that deals with plumbing or electricity. The project may be simple, but the consequences of doing it wrong can be costly. Many times there are great benefits in turning to someone who has the appropriate experience. The valuation process certainly has pitfalls. A good rule of thumb is that the larger, more valuable the real estate, the more sense it makes to hire a professional.
Copyright © 2018 by Steve Nowak
Steve Nowak Disclaimer: The contents of this article are intended to convey general information only and not to provide legal advice or opinions. The IRS has rules and regulations regarding who can perform work related to real estate held in a self-directed IRA. The contents of this article, and the posting and viewing of the information contained should not be construed as, and should not be relied upon for, legal or tax advice in any particular circumstance or fact situation. This article is intended to inform the general public of the public’s legal rights. No formal legal action should be taken in reliance on the information contained in this article and the author disclaims any and all liability in respect to actions taken or not taken based on any or all of the contents of this article to the fullest extent permitted by law. An attorney should be contacted for advice on specific property or specific real property tax appeal.
Steve Nowak is not an employee of Equity Trust Company. Opinions or ideas expressed by Steve are not necessarily those of Equity Trust Company nor do they reflect their views or endorsement. These materials are for informational purposes only. Equity Trust Company, Equity University and their affiliates, representatives and officers do not provide legal or tax advice. Investing involves risk, including possible loss of principal.
Equity Trust is a passive custodian and does not provide tax, legal or investment advice. Any information communicated by Equity Trust is for educational purposes only, and should not be construed as tax, legal or investment advice. Whenever making an investment decision, please consult with your tax attorney or financial professional.