What Is Ad Valorem Tax? A Guide For Real Estate Investors

Key Takeaways


Almost nobody likes paying taxes, but they are a necessary component of regular life. Think about property tax, income tax, or even sales tax — you likely encounter at least one of these every single day. After all, taxes are how governments of all levels earn their income. Despite how common taxes are, many individuals are unaware of how different types are calculated and why. An ad valorem tax is the perfect example.

These taxes are levied differently depending on the item in question. While it may seem pointless to learn how they work, understanding different taxes can help your real estate business in more ways than one. Keep reading to learn more about how ad valorem taxes are applied in real estate and where you can use this information in your next deal.

What Is Ad Valorem Tax?

An ad valorem tax is based on the value of an item at the time of the transaction or assessment. The name of the tax stems from a Latin phrase and means “according to value.” Essentially, ad valorem taxes are determined based on the appraised value of the item at hand. Ad valorem taxes are commonly applied at a state and local level and often make up a large portion of government income.

Ad valorem is a broad category of taxes and makes up many of the tax types that exist in the United States. These taxes can either be applied to a transaction or calculated and charged on an annual basis. Ad valorem taxes are commonly used with real estate, personal property, or other goods and services. One of the most common examples of an ad valorem tax is property tax.


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Ad Valorem Tax In Real Estate

Ad valorem taxes are applied to several areas of real estate. They are typically regulated by local governments and charged on an annual basis — or in some cases when a property is bought or sold. These taxes are determined as a portion of the appraised property value, which the county tax assessor decides. There are a few different types of ad valorem taxes in real estate:

  • Property Taxes: This is the ad valorem tax most people are already familiar with. Property taxes are determined and charged on an annual basis — and can increase over time depending on the value of the home.

  • Capital Gains: Capital gains taxes are typically applied when you sell a high-value investment, in this case: real estate. These taxes will be determined based on the value of the property sold at the time of the transaction.

  • Transfer Costs: Did you know that a portion of closing costs is considered to be an ad valorem tax? Transfer costs are taxes based on the sale price of a property and are charged when ownership changes from the seller to the buyer.

What Properties Are Subject To Ad Valorem Tax?

All properties are subject to ad valorem taxes, most commonly in the form of property tax. Property taxes are charged on an annual basis and apply to residential and commercial properties, as well as raw or vacant land. Ad valorem taxes can be applied to home renovations or building improvements.

Besides real estate, ad valorem taxes are also levied on high-value personal property (such as cars or boats). In these cases, personal property taxes are charged annually by the local government as part of ownership. Appliances or high-value personal belongings, like jewelry or clothing, are typically exempt from ad valorem taxes.

How Is Ad Valorem Tax Calculated?

Ad valorem taxes are calculated as a percentage of the item being taxed. For example, when it comes to property taxes, a professional assessor will determine the home’s market value. They will then apply the percentage charged in your area, a rate that is commonly referred to as a mill levy. A simple ad valorem tax calculator for property taxes would therefore be:

Property Value x Mill Levy = Ad Valorem Tax Due

When it comes to personal property, ad valorem taxes are calculated similarly. An assessor will determine the value of the item, taking depreciation into consideration. They will then use the tax rate set in your local area to determine the cost of the ad valorem tax.

How To Determine Ad Valorem Tax Value

You will need your property value and information on your county’s tax rate to determine an ad valorem tax value for real estate. When it comes to property value, consider the sale prices of similar homes in your area. You will also want to calculate the return on investment (ROI) of any renovations completed on the property. As a bonus, this information can help should your tax assessor ever overvalue the home. After you have an idea of your property value, look up your county’s property tax rate (or mill levy). This number can change from year to year but will always be available on your local government website. You can then use these futures to determine the ad valorem tax value of your property.

Summary

Taxes are charged almost every time you buy or sell something, yet most individuals rarely look past the percentage they see on bills. As a real estate investor, it is crucial to understand how taxes are calculated, especially ad valorem tax rates. This information will help you avoid overpaying property taxes, estimate transaction costs, and even maintain your budget over time. Remember, it is crucial to brush up on your financial education if you want to achieve your goal in real estate — even when that means reviewing tax policy.

What are some common ad valorem tax examples we left out? Share your thoughts in the comments below.


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