Thursday, February 15, 2007

The Real Estate Tax Must be Fixed

Real estate assessments are skyrocketing and the natives along both banks of the James are getting restless. Governor Kaine supports an amendment to the Virginia Constitution that would allow local jurisdictions to exempt as much as 20% of the value of a home from real estate taxes. Mayor Wilder has proposed that increases in property assessments be limited to 10% per year. The Richmond City Council is considering a proposal that would allow homeowners to defer payment of any annual real estate tax increase in excess of 5%. Unfortunately, none of these proposals go far enough in dealing with what is perhaps the most oppressive tax we have to pay.

Although real estate taxes have been the predominant means of local government financing in Virginia for hundreds of years, the tax on real estate is the least fair of taxes. The tax is unfair because it bears no relationship to the ability of the taxpayer to pay or to the level of municipal or county services that she or he receives.

I bought my Richmond home only two years ago. Since then, the assessed value of my property has gone up more than $60,000. My assessment notices have not explained how the assessor determined the basis of this increase. The Code of Virginia and the Richmond City Code requires the assessor to assess for tax purposes all real estate in the city “at its fair market value.” There is, however, only one way to actually determine the fair market value of property—to put it on the market and see what price the seller and buyer agree on. Any other determination is only an approximation based on recent sales of property that may be different in style, condition and age and may be located some distance from the property being assessed.

Even if the assessment does approximate the actual market value of the property, taxes levied on the assessment are unfair. If I bought my house for $200,000, and then a neighbor on the next block sells his for $230,000 and another neighbor sells hers for $225,000, I have gained nothing. To me, my house is worth no more than what I paid for it. My neighbors may have sold their homes at a profit but I received no part of their profit. It could be argued that the equity in my home has increased, but until I sell my house, or refinance it to get access to the equity, it is merely a hypothetical gain. It is grossly unfair to increase my real estate tax when I have gained nothing from the property sales in my neighborhood.

Further, it is terribly unfair for taxpayers in a jurisdiction to pay different amounts in taxes for the same municipal services. In the City of Richmond, a citizen receives the same level of city services whether he or she pays $2,000 or $4,000 or more per year in real estate taxes.

Of course, our elected representatives—whether supervisors or council persons—love the real estate assessment process. It provides them with significant increases in revenue to spend each year without ever having to vote to increase taxes. In fact they can appear to be heroes by cutting the tax rate by two or three cents, and still have most of the increase revenue.

In the interests of fairness and to avoid further alienating citizens who are suffering significant hardships in paying constantly rising real estate taxes, our legislators need to act to fix the real estate tax. Unfortunately, none of the existing proposals provide the necessary fix.

Governor Kaine’s proposal, if fully implemented, would leave homeowners still paying taxes on 80% of the assessed value of their property, and would have no effect on rapidly rising assessments. Also, because it relies on a constitutional amendment, it cannot be implemented quickly.

Mayor Wilder’s proposal would necessitate a change in state law. Currently, Title 58.1, section 58.1-3201, of the Virginia Code requires real property to be assessed at 100% of its fair market value. The City’s Assessor has no authority to restrict assessment increases to 10% as suggested by the mayor. Further, even if authorized by the General Assembly, under Mr. Wilder’s proposal homeowners would still face yearly increases of 10% in their real estate taxes.

The proposal in the City Council would merely allow homeowners to delay the pain of paying taxes on the constantly increasing assessed value of their property. The taxes would continue to accrue and eventually the homeowners who chose to defer would have to pay the entire amount of the deferred tax, plus interest.

The only real solution to the inequity of the real estate tax is for the tax to be eliminated and for some other mechanism for financing local government to be found. It is not likely that this will happen any time soon. In the mean time, the General Assembly and the Richmond City Council need to take action to rein in real estate assessments. I suggest the following approach:
1- All assessments are to be frozen at their current level (or preferably rolled back to their January 2006 level);
2- Owners of real estate will pay taxes based on the current assessment until either they sell the property or refinance to access their equity in the property;
3- Sellers or owners of refinanced property will pay a real estate surtax at settlement based on the increased value of the property;
4- After sale or refinance the assessment will be adjusted to the sale price or the appraisal that is the basis of the refinancing. The owner of the property will then pay taxes based on the new assessment.

I certainly am not an expert on the law of real estate taxes. I do not know whether my proposal needs a constitutional amendment, a law passed by the General Assembly, or an ordinance passed by City Council. I urge Governor Kaine, Mayor Wilder, members of the General Assembly, and members of the City Council to get serious about the tax hardship being faced by homeowners. Only a change in the assessment process can fix the real estate tax.


The Yankee said...

Your analysis of the problem, and of the various proposed solutions that are on the table, is right on target. I do have a few quibbles about your plan, though.

If you sell your property at a profit, you will owe real estate taxes based on the idea that the value of the property actually increased some time earlier and you weren't taxed at that time on the increased value. Is there a fair way to calculate this belated tax?

Let's say that you lived in the house for 20 years. If the value was constant for the first 19 years, and then jumped in the last year, the tax should have risen only one year ago. If the value went up in the first year, and then was constant for the last 19 years, the tax should have been higher for 19 years. Since there's no way to figure out how long the house was under-assessed, there's no fair way to calculate the surcharge.

There are other issues as well. What happens if the property becomes so valuable that the owner can't afford to sell and incur the surcharge? And how does the city stay solvent when revenue falls behind inflation, because 95% of properties cannot be revalued in any given year?

Wouldn't it be fairer if valuations were fixed in constant-value dollars (that is, indexed to inflation) until the property is sold? That would allow the community to maintain its revenue stream without making homeowners pay taxes based unrealized gains caused by a rising real estate market.

Of course, if the property itself changed (such as by adding another story to the house), a change in the real estate tax would be appropriate. But such a change should be based objectively on the change in the property, not on market prices. For example, if you added a floor to your house, the city might calculate the percent increase in floor space, and then increase the assessment by some fraction of that percentage. That would allow people to improve their property without being slammed by huge tax increases based on rising market prices.

If at any time a property owner thought that the calculated valuation was higher than the actual value of the property on the open market, he ought to be able to apply for (and, if successful, lock in) a downward adjustment.

Finally, the valuation would have to be adjusted based on the actual market value of the property whenever the house is sold. In most cases, the new valuation would be the actual sale price. But the city should also do a traditional assessment, and if the city finds that the market price is far too low (perhaps more than 10% below market), it should use its own valuation instead. To prevent unpleasant surprises after the sale, the city should provide a document stating the valuation before closing.

Roger Mc Cauley said...

The complexities described by the Commentor (above) are a perfect example of how much tax policies impact on our decision making process.

I say junk the whole thing. Read about The Fair Tax Plan in another of the Maven's messages and my comments as well.