Real Estate Tax (part 2)

In my earlier post (February 15, 2007), I explained why the real estate assessment-taxation process is inherently unfair. I argued for the repeal of this obsolete tax and its replacement by another source for local government revenue. I realized that this repeal would not take place soon, so I proposed the following fix to make the real estate tax more equitable:

1- All assessments are frozen at their current level (or preferably rolled back to their January 2006 level);
2- Owners of real estate 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 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.

I received a comment from somebody who calls himself the Yankee (I assume that means s/he is a member of some New York sports team.) The Yankee said,


"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."

The Yankee misinterpreted my proposal. I did not propose that the entire amount of taxes that would have been paid under a yearly reassessment should be paid when the house is sold. I proposed a one time surtax of five or ten percent of the profit that the homeowner realizes from the sale.

"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?"

Since the surtax will only be a percentage of the profit the property owner realizes in selling the property, the property will never get to valuable to sell. As far as the revenue flow to the local government, the Yankee needs to realize that the real-estate tax a property owner pays is only partly dependent on the assessed value. The local government, whether it is a county board of supervisors or a city council still must establish a tax each year. For example, the 2006 tax rate for the City of Richmond was $1.29 per $100 of assessed value. Presumably, if the projected revenue in any year is insufficient to operate the local government, the board of supervisors or city council can raise the tax rate.

"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."

This might help a bit. However, when the rate of inflation is one or two percent but the annual assessment rate is going up fifteen or twenty percent, as it has this year in Virginia, indexing will not cure the problem.

"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."

The City of Richmond has a tax abatement program that delays the reassessment of certain property when the homeowner makes improvements. If the house is more than twenty years old and the improvements increase the value of the property more than 20% the homeowner may defer all or part of the increased value for up to ten years.

"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."

In Richmond, any property owner who disagrees with a reassessment may appeal. However, the burden is on the taxpayer to prove that the assessment was wrong. It may be difficult to establish that the assessment was in error.

"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."

I have to disagree with the Yankee. The sale price that a willing seller and willing buyer agree on is the fair market value of the property. It is not relevant that other properties in the neighborhood may be selling for a higher price. The problem with using the sales of other properties as a basis for assessment is that no two properties are identical. Houses differ in size, model, and age, and each house has a different location. The actual sale price of the property is its fair market value.