Are you aware that property tax rates can differ for different properties? They can. Here in Tennessee for example, commercial property is taxed at a higher rate than residential property. Not knowing and understanding how these different rates apply could cause you to make a mistake during your property analysis and crimp your cash flow.
To understand how these two tax rates work we have to first define some terms.
Let’s look first at what “residential” property is.
Residential property as per Tennessee Code Annotated is a single family dwelling or a duplex where the owner is an owner/occupant and lives in one side of the duplex. So to be classified as residential property, an owner of a duplex must live in one of the units. A singly family dwelling is always classified as residential, no matter where the owner lives.
So what is “commercial” property then?
It is just about everything else.
Commercial property includes properties that you would ordinarily describe as commercial, such as strip shopping centers and office buildings. This category also includes industrial buildings and multi-family buildings. It includes large apartment complexes and smaller buildings like tri-plexes and quad-plexes, no matter if the owner lives in one of the units or not. It also includes duplexes if the owner does not reside in one of the units.
So what is the difference between these two property classifications when it comes to property taxes?
It’s 15%.
Residential properties are assessed at 25% of their appraised value for property tax purposes. Commercial properties are assessed at 40% of their appraised value.
Let’s look at an example and how it might affect you.
You have found an owner occupied duplex that you wish to purchase. As you do your research on the property, you look up the current taxes and plug them into your spreadsheet. The property cashflows well, so you decide to buy it and add it to your portfolio.
To make it easy, let’s say the property’s appraised value is $100,000 and as an investor, you have no plans to live there. At the closing table, your attorney places your office address on the deed so everyone knows where to send tax bills. This change in ownership will trigger the local tax assessors’ office to reassess the property to the higher commercial rate of 40%.
Now, instead of paying taxes based on $25,000 of value ($100,000*25%) you will be paying taxes based on $40,000 of value ($100,000*40%). Here in Memphis and Shelby County, TN that can be a huge difference as this change in assessment amounts to a tax increase of over $1,100 per year.
Ouch! That’s almost $100 more per month. Double ouch if you were not expecting it because you based your calculations on the residential rates.
I would bet that it is safe to say that other state do similar things. Please be aware of these potential tax rate differences and how they might affect you. Your cashflow depends on it.
There’s many other ways to end up with taxes that make you scratch your head. Here we have not had a re-evaluation of the assessments in 25 years, with one area of the city gentrifying tremendously in that time and rising in value at a higher rate. Thus there are some $1m houses paying roughly 1% of value, and some $250k houses paying 3 or 4 times that. Plus there are many tax abated properties in redevelopment zones that come off abatement at different times, and free market new construction paying on a realistic assessment, 2.5 times their historic neighbor. Fun no? Some folks with low taxes have sold recently fearing a reval will drop their home price.
And then there’s NYC, where the residential taxes are held at ridiculously low levels, less than 1/4 of comparable over any of the city’s borders, subsidized by commercial taxes. Sounds attractive, but the prices are astronomical and they have a city income tax to boot.
Jon,
Tax assessments can be maddening. I am dealing with that on several of my properties now. Thanks for taking the time to read and share,
Kevin