What is Ad Valorem Tax?
Ad valorem tax refers to those charges imposed by a government based on the value of a transaction or particular property. It is a Latin phrase directly translating to "according to value." It is most commonly used to refer to the property tax that is assessed on real estate, personal property, and personal property leased or that may be purchased at the end of a period of time. It can also be applied to an excise tax based on the value of a specific good, such as tobacco or gasoline.
For instance, if the county where you live has a 1% ad valorem tax on your car and your car is valued at $20,000, you will pay $200 per year for the right to drive that car on public roads . Conversely, imagine a 3% ad valorem tax on your car and a 90% value for $20,000. That’s a $18,000 tax bill per year for the privilege of driving a car on public roads. Notice that only one of these examples makes sense; a mere 1% tax rate is easy to digest. A 3% tax rate on every $20,000 is not something people would find appealing. Imagine a 3% tax on all of the cars in the county multiplied by the 90% of value and you can see how ad valorem tax can be problematic.
There are many types of taxes in existence today; sales and business taxes are not considered ad valorem and are therefore not included in this article.
Ad Valorem Tax in the State of Texas
Ad valorem taxes in Texas are assessed on real property (land, improvements to land, oil and gas, etc.) as well as personal property (in other words, equipment, furniture, vehicles, raw materials, etc.) Though in many states there are differences in the laws governing real versus personal property, in Texas, the Uniform Property Tax Code applies to both, so assessment is fairly straightforward once one gets past the legal framework.
In Texas, ad valorem taxes are assessed based on the value, as determined by the central appraisal district (CAD) for the county where your property lies, every year. Many folks who consider filing a business personal property report to the CAD simply do not bother because the value of their personal property is below the CAD’s threshold and they believe they will not be taxed, so why bother? Well, what does that say for the tax assessor? In Texas, the CAD is allowed to make some estimates based on information like NAIC (National Association of Insurance Commissioners) codes, so even if you have below-threshold values, you still need to file with the CAD if you do not want the CAD potentially overtaxing you.
Among the most common exemptions from ad valorem taxation is the homestead exemption. A taxpayer’s primary residence is exempt as homestead under section 11.13 of the Texas Tax Code. There are also exemptions for certain types of property and certain types of entities. For example, properties used or held for residential use are exempt so long as the profit from sale of the property is used to build or buy another property for the same purpose. Other exemptions include, but are not limited to, exemptions for agricultural, nonprofit, religious, charitable, educational, and veteran’s property as well as exemptions for inventory and special-use property such as solar energy equipment.
While ad valorem tax generalizations can be useful, the burden of researching what is taxable and what is not primarily falls on the taxpayer. As such, it is necessary to have the right professionals on hand to assist you with your ad valorem tax matters. Remember: ignorance is not bliss.
The CAD often assess property at higher than its actual value, especially when compared to property that is similar (also known as the equity principle). Because CADs are required to assess property at fair market value every year, they are generally very aggressive in their assessments. The CADs generally consider locational data and/or other physical characteristics that set a particular property apart from comparable properties. If a property is assessed at a higher amount than similar properties, taxpayers have the right to go and plead their case for lower value to the appraisal review board (ARB). Of course, that requires the taxpayer to know about how much others similar to their property are assessed.
Tax rates (also known as tax burdens) vary widely throughout Texas and the country. Ad valorem taxes in Texas can be very high. While there is no statewide rate per se, the average is approximately 1.6%. Some taxing jurisdictions in Texas have tax burdens much higher than that. Tariff bills (for taxable personal property) are among some of the largest ad valorem tax burdens, which may result from an attempt by the Texas Legislature to induce utility companies to come to Texas to lower the electric costs of Texans, or an attempt to grow the natural gas sector (as opposed to electric utilities). The tax burden in Houston is among the largest in the state of Texas at 2.5%.
How is Ad Valorem Tax Calculated?
In Texas, ad valorem property tax is calculated by assessing the value of real estate and personal property. A county appraisal district staff member typically assesses the value of the property. The appraisal district will contact the owner of the land and make an effort to learn how much similar properties sold for. The value is based on the supply and demand for property and can be influenced by a variety of factors. For example, if more owners are looking to buy in an area, the value of the land may increase due to demand. High-quality schools and other amenities also influence values.
The appraisal districts in Texas can have a big say in the value of properties. They can negatively impact the value of a property if they incorrectly consider the value of a parcel to be much higher than its market value or if they do not observe the requirements of the Texas Property Tax Code. It’s vital to identify the market value of your property and whether it may be unequal to similar properties, or inequitably appraised. This requires looking closely at the process of how valuation occurs.
Another factor is tax levies. Taxing entities within Texas set a tax levy on a property, which is an amount calculated by multiplying the appraised value of the property by the levy set by each entity. The result is property tax owed to that entity.
Tax levies can be changed up or down from year to year, which affects the amount of the property tax. Since tax levies are a function of budgets, they can increase and roll back, which is done when taxes are considered excessive. In Texas, there are many entities that can levy taxes, including cities, counties, school districts, and other more local districts. Since these entities all set their own levies, the overall tax on a property can be substantial.
An owner of a property in Texas can protest their property’s value. Two different boards will review the protest, one for the value and one for the equity among similar properties. By taking advantage of these hearings, an owner can often obtain lower tax amounts and file a motion with the courts to further reduce the amount if necessary.
Payment of Ad Valorem Tax in Texas
Much like paying other taxes, ad valorem taxes in Texas can be paid through a number of different methods. However, before discussing the mechanics of paying such taxes, it is essential to know when they are due. Under Tex. Tax Code Ann. § 31.01, the deadline for paying ad valorem taxes in Texas is:
(1) January 31 of the calendar year after the year in which the taxes
on the property were assessed;
(2) if January 31 falls on a Saturday, Sunday, or legal
holiday, the day following that date; and
By statute, ad valorem taxes in Texas can be paid in one of two ways. The first option is to pay the tax directly to the county tax assessor collector’s office. The second method is to pay through a mortgagor (generally a bank who holds a deed of trust on a homestead property (as defined under Tex. Const. art. XVI, secs. 50-51) and/or another lien on the homestead property). See Tex. Tax Code Ann. § 31.04(a).
If payment of the tax bill goes through the mortgage lender or mortgage servicer, the lender or guarantor: (1) determines the amount of taxes due; (2) forwards any adjustments to the amount of taxes to the mortgage insurer if there are no taxes due, and forwards any adjustments in the taxes to the borrower and the insurer; and (3) pays from escrow the taxes owed to the tax authority. See 34 Tex. Admin. Code § 5.408(a)(2)(B). If there is a moratorium on escrow, the mortgage lender must notify the borrower if it receives a tax statement within 90 days of the date that the mortgage lender notifies the borrower of the moratorium. Id. at § 5.408(a)(4).
If a mortgagee does not pay a borrower’s ad valorem tax bill by the due date, the borrower should send all future payments directly to the tax authority with a letter explaining that the mortgagee no longer escrows for taxes. A mortgagee can collect from the borrower for any delinquent payment, including penalties and interest, if the mortgage contract provides for it, but if the mortgage does not provide for such collection, then the mortgagee must wait until the borrower defaults on the mortgage before seeking any collection remedies. See 7-many Lenders, Mortgage Servicers May Hold Escrow Accounts: State Law Developments, 86 Texas Bar Journal 164 (Feb. 2018). If payments are going through a third party servicer, then (under the guidelines set forth in the Servicemembers’ Civil Relief Act), payments should be sent to the servicer.
Exemptions and Reductions
Unfortunately, tax reductions are not all that common in the great State of Texas. The Texas Constitution empowers the Texas Legislature to grant tax reductions or exemptions to "all real and personal property", subject to the terms of those granting the exemptions.
Like many laws, exceptions have been read into the Constitution. The remaining exemptions are not so numerous as you might believe.
Homestead Exemptions
Texas provides some of the best homestead tax exemptions in the country. A "homestead" is a dwelling constructed on a tract of land owned by a person. If the person owns multiple tracts of land, the land must be contiguous to qualify. Additionally, the tract of land must be used as a permanent residence. It cannot be used for investment purposes, such as a rental property.
A "residence" is broadly defined in the statutory code, and includes any location that will eventually serve as a permanent resident. This broad interpretation allows for structures built for other purposes to qualify as a homestead if they meet the requirements.
If the property qualifies as a homestead, the owner receives a tax exemption. There are several categories of homestead exemptions, including general, over-65, disabled and disabled veteran. Among these exemptions, the general homestead exemption provides the most benefit . The amount of general homestead exemption is equal to $15,000 of the homestead value.
In addition to this general exemption, taxes are not levied by cities or counties for the first $12,000 of property value. The result of these exemptions is a significant reduction in the homestead value for taxation purposes.
Veteran Exemptions
The chief dollar value exemption for veterans is the disabled veteran exemption. This exemption comes into play if the veteran received an honorable discharge from active duty and can show this through the Department of Defense Form DD 214. The Department of Transportation must have rated the veteran’s disability to be a minimum of 10 percent. The greater the rating of disability, the higher the exemption amount. Ranging from $5,000 to $25,000, this exemption removes part of the value of the real or personal property that is owned by a veteran suffering from a disability.
The reduced valuation lowers the ad valorem taxes assigned to the property. The exemption can apply to any kind of property that the veteran owns, including real property, personal property or both.
Other Exemptions
The current law only provides a tax exemption for churches and religious organizations. Non-profit organizations may also qualify for an exemption under the code.
Challenges/Disputes
Property owners frequently bring to our attention the aspect of ad valorem taxes they dislike the most: the perceived unfairness and/or inaccuracy of the taxable value assigned to their property by the applicable appraisal district. The Texas tax code provides taxpayers with a means of remedying these complaints through an administrative objection process and a judicial appeal process. One common complaint we hear from our clients is that too much emphasis is placed on the "market" value of their property and not enough emphasis is placed on the actual earning potential of their property. For example, many taxpayers tell us their property has excess land (over and above what is utilized for the taxpayer’s business) that is rarely or never leased or utilized for income-generating purposes. This excess land is not being utilized as part of the taxpayer’s business, but is nevertheless included in the ad valorem tax value of the taxpayer’s property as though the excess land were an integral component of the taxpayer’s business, with a value based on its market value rather than its income-generating contribution to the taxpayer’s business. Another common complaint is that the appraisal district takes too narrow a view of the use of the taxpayer’s property for purposes of the appraisal district’s revenue generation goals. For example, several of our clients would prefer to demolish older buildings and replace them with new, more valuable buildings. But the appraisal district’s practice is to add the value of the new construction to the taxpayer’s property value whereas the taxpayer’s present practice is to construct new buildings or additions to its existing buildings only when previously constructed buildings or additions are fully depreciated and have no present value. The taxpayer’s practice, at least for tax purposes, is to change the use of its property rather than to add to its property holdings and because of this tax treatment, the appraisal district does not agree that the entire parcel should be assessed on a "future use" basis. These complaints may be remedied through two tax processes found in the Texas tax code: the administrative objection process and the judicial appeal system. These processes are discussed in more detail on the Tax Issues page of this site, but we provide a brief overview of each of these processes below, because each taxpayer must choose one or the other to pursue their complaints.
Taxpayers may object to the appraisal district’s property value assigned to the taxpayer’s owned or leased property by a written objection that includes the specific value being challenged and the reasons for the objection. Although this process is administrative in nature, the law contains many detailed, specific deadlines a taxpayer must follow. A timely filed objection results in a meeting between the taxpayer and representatives of the appraisal district. If the parties reach agreement on the property value, the case is over. If not, they may request that the appraisal review board hold a hearing and issue its formal written ruling on the value and other contested issues. This hearing process is called a "property value study." Because the property value study process is compulsory, the taxpayer has the right to attend, present evidence and information, which the appraisal review board must take into consideration. A Tax Code section 41.43 appeal may be taken from the property value study ruling of the appraisal review board in district court. If the taxpayer is not satisfied with the appraisal district’s proposed property value and the parties do not reach agreement through a property value study meeting, the taxpayer may file a timely protest with the appraisal review board. If the taxpayer’s district and market value appeals are heard by the same appraisal review board, the taxpayer may elect to have a single hearing address the appeal of both proposed values. If the taxpayer’s district and market value appeals are to be addressed by two separate appraisal review boards, the taxpayer’s protests must be filed by the following deadlines: A ruling by the appraisal review board is not final, unless the appraisal review board and the taxpayer both sign a written agreement that sets forth the ruling of the appraisal review board and the protest agreement of the parties. If there is no agreement, either party can seek judicial review in district court by filing a petition no later than August 15 of the year in which the property value study of the appraisal review board is issued.
Ad Valorem Tax and Residents and Businesses of Texas
For many residents and businesses in Texas, this tax plays a crucial role in their overall financial planning strategies. The amount of ad valorem tax credit that a Texas resident can claim may substantially reduce their overall tax burden. Most residents expect tax credits to be available at the end of the tax year when they submit their annual tax returns.
However, some of these credits are actually available during the course of the year in the form of reduced property taxes. The state of Texas allows property owners to deduct their property tax payments from their annual state tax burden. Most homeowners will be able to deduct up to $375 on their state income taxes, while larger corporations and residential dwelling owners can benefit from even more annual savings.
Whether they are personal or professional, all real estate decisions in Texas must consider ad valorem taxes. Real estate investors and business owners must consider the impact of new property taxes on their overall tax liability. Large corporations often face a major state tax bill at the end of the year if they qualify as a franchise taxpayer. Even small to medium tax businesses need to account for their personal property, real property and franchises.
Future of Texas Ad Valorem Tax
The future of ad valorem tax in Texas is poised for further evolution. As the state’s economy continues to grow and diversify, there will be an increased need for public services without a similarly sized increase in cash inflow. For this reason, Texas legislators will continue to rely on ad valorem tax as a means of providing much needed operations and maintenance funds to governmental entities . In addition, the growing population across the state can give rise to new development and repositioning of localized property such that there is new market value added to local tax rolls.
On the other hand, with recent increases in ad valorem taxes and the effect of Texas’ Truth-in-Taxation Law, the Texas Legislature may review changes to the existing framework for the application of ad valorem taxes in order to either temper revenue from ad valorem taxes or to limit the ability of local taxing authorities to increase ad valorem taxes.