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Ecology of Money

How Retirees Can Pay Less in Real Estate Taxes

Contributor John Wasik outlines tax-saving strategies for those staying put and those willing to pull up stakes.

Note: This article is part of Morningstar's February 2016 Tax Relief Week special report.

Real estate offers some of the most generous tax breaks around. You're already familiar with the biggest ones: mortgage interest and property taxes. But retirees can potentially save many more tax dollars if they're willing to invest some time and research.

The first question to ask is if you plan to stay in your home within the next year or two. For those staying put, a much different strategy is needed than those relocating.

Tax Savings for Retirees Not Moving
Your local assessor or county clerk is a good source for property tax breaks that you may be entitled to. Depending on location, income, age, and/or circumstance, retirees may find that they are entitled to the following:

  • Elderly/Senior Tax Exemptions or Freezes. Depending on the location, these breaks are offered to homeowners aged 60 or 65 and older. These breaks will either freeze valuations or lower the amount of property tax outright. A common exemption is a "homestead" designation for those who own and live in a home.

  • Property Tax Deferral. For those unable to pay their real estate taxes, the state or local agency may allow you to delay payment, although you will still owe the tax.

  • Veterans' Breaks. Assessors may also grant exemptions for disabled or returning veterans.

Another strategy for reducing your property taxes in retirement: Challenge how your home is valued. The assessment process, handled locally, is one of the foundations of your real estate tax bill.

Depending upon the area, some 30% to 60% of all properties are overassessed, according to the National Taxpayer's Union (NTU). That results in a higher property tax bill.

Despite this disparity, only 5% of homeowners challenge their assessments, the NTU found. While the process of assessing value is a fuzzy business, there's a solid way of challenging what your property is worth. This is one way to lower your real estate tax bill, especially for retirees looking to cut their living expenses.

Always check your property descriptions first, which are common sources of errors. Does your home have only two bathrooms but your assessment says you have three? Does the assessment say you have a basement when you don't? If the property description is wrong, then you could be overassessed.

Remember that your property is assessed based on its size, overall living space, amenities, and value relative to similar homes around you.

Next, compare the assessed value of your home with similar homes in your neighborhood. If you have a two-story, four-bedroom home with attached garage, compare it with the assessments and market values of like properties. If your home is being assessed at a higher value than others, you have a case for an assessment appeal. At the very least, you can argue that your assessment is not uniform and the value is too high.

On the local level, the first place to start in challenging your property value is your assessor. They have all of the public records on assessments and can easily fix blatant errors. Assessed values are also published in local newspapers once a year. If your assessor can't help you, you can appeal your assessment to your county tax appeal board.

Although establishing property values is a fine art--it's usually based on recent sales of similar homes--you can find help in filing appeals.

Many local lawyers and appraisers offer this service. Enter "assessment appeals" and your county into a search engine and you can find them. They typically charge a low flat fee plus a percentage (usually about one third) of your annual tax savings--if your appeal is successful. Since I live in a high-tax area, I go through this process every year. One year, I knocked $1,000 off my property taxes.

Just keep in mind that assessors don't always keep up with changes in real estate values. Your best opportunity to save on taxes comes when market values drop. Also, pay attention to the time window for filing an appeal. It's always well before your tax bill comes out and is limited to a month or so.

What About Retirees With Multiple Properties?
You can also challenge assessments on other properties you own, whether they are vacation or rental properties. The process, described above, is the same. Just bear in mind that you may not qualify for some of the age-related "homestead" exemptions if these properties are not your principal residence.

Income tax breaks on nonprimary properties get a little complicated, though. While you can deduct mortgage interest and property taxes, there are limits, according to the IRS:

  • The combined cap for mortgage interest on your primary and secondary residences for a married couple filing a joint return, or an unmarried taxpayer is $1 million on mortgages and $100,000 for home-equity loans.

  • If you rent out a home, you must use it for more than 14 days or more than 10% of the number of days you rent it out, whichever is longer.

  • Deductible real estate taxes include any state, local, or foreign taxes based on the value of the property "levied for the general public welfare."

  • Real estate tax write-offs do not include taxes charged for "local benefits and improvements that increase the value of the property, such as assessments for sidewalks, water mains, sewer lines, parking lots, and similar improvements."

Strategies for Retirees Willing to Move
Saving taxes through relocation involves much more homework. Not only do you need to see how much different states charge for income tax, you need to vet the total tax burden imposed. That means adding up property, sales, income, and other local taxes for each locale you're considering.

State income taxes are the easiest part of this puzzle. Only a handful of states don't charge this tax: Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington, and Wyoming. But your homework shouldn't stop there. You have to look at an array of taxes before you make a decision.

For example, let's say you're considering a Sunbelt state and want to move out of high (property) tax states like New Jersey, New York, Connecticut, and Illinois. You might consider where the lowest property taxes are paid, which, according to the Tax Foundation, would be Alaska and Louisiana.

Are those states too remote for you? Then, use this as a benchmark: The average American household pays about $2,000 in annual property taxes. New Jersey is going to be on the high end with bills pushing into the five figures. Click here for a recent study of property taxes by state.

Your gauge should be what you're paying now. Densely populated urban areas with myriad services are going to charge you much more than rural areas. Generally, southern states like Alabama and Arkansas--and surprisingly Hawaii--have the lowest property tax rates.

But remember, in the case of relocation, you need to consider the total tax burden, since property taxes don't tell the whole story. The trend is similar: Populous states like New York have the highest state and local taxes, while the least-populated states like Alaska, South Dakota, and Wyoming have the lowest overall taxes. Texas also makes the list of states with the lowest total taxes.

Focusing on local taxes and services is a good way to discern how much a property will cost you over time, since state and local taxes generally take up about 73% of your real estate tax bill.

Another rule of thumb is to examine the growth rate in the areas you're considering. High-growth areas need schools, fire stations, libraries, and other services. Local taxes often have to be raised to pay for those amenities.

Always sit down with your tax planner before you make a move. Estate laws also vary by state, so it's best to get a full review of what a move will cost you before you schedule the moving truck.

John F. Wasik is a freelance columnist for Morningstar.com and author of 14 books, including Keynes's Way to Wealth: Timeless Investment Lessons from the Great Economist. The views expressed in this article do not necessarily reflect the views of Morningstar.com.

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