In Part I I covered the basics of what property taxes are. This time I’ll dive into how exactly property taxes are calculated, starting with (for Minneapolis) the half billion dollar question.
What is tax capacity?
In its simplest form, the tax capacity of a property is its taxable market value (explained below) multiplied by its class rate (also explained below). This will give the tax capacity of the property, which is used, along with the tax capacity rate, to determine the property tax bill. In this usage, tax capacity is unrelated to the macroeconomic concept of tax capacity.
Taxable market value?
All properties have a “market value” which is simply the estimated real market value of the property. For the case of commercial, industrial, and certain types of residential property, the taxable market value is the same as the market value. This means the full value of the property is used to calculate the tax capacity, and therefore the full value of the property is taxed.
In some cases, however, a portion of the market value is excluded from taxation. The largest and most impactful of these exclusions is the homestead exclusion, but there is also an exclusion for homesteads of disabled veterans. There are no other exclusions that I am aware of.
The homestead exclusion excludes a portion of the market value of the property from taxes if it is used as the property owner’s primary residence. Based on the formula used to calculate the exclusion, the exclusion becomes zero at about $414,000 of property value. The amount of the exclusion is 40% of the first $76,000 in value minus 9% of the value over $76,000. For a house valued at $190,000, which is about the median value in Minneapolis, the exclusion would be ($76,000 x 40%) – ($114,000 x 9%), or $20,140. The $114,000 here is the value of the house over $76,000. Then we subtract this exclusion from the value of the home, so $190,000 – $20,140, for a taxable market value of $169,860.
The disabled veteran’s exclusion excludes the first $300,000 of value from a veteran’s homestead from property tax.
For all other types of properties, commercial, industrial, and non-homesteaded residential, the taxable market value is the same as the estimated market value.
Now that I’ve got my taxable market value, what is the class rate?
Minnesota classifies property by its current use, which determines the class rate. At a mathematical level, it is a percentage that is multiplied by the taxable market value. At a policy level, it means different types of uses are taxed at different levels. Residential property is generally taxed at a lower rate than industrial or commercial property.
You’ll remember from before that homesteads get a portion of their value excluded from property taxes altogether. They also get more favorable rates than non-homesteaded properties. The first $500,000 in taxable market value of a homesteaded property has a rate of 1.00% and the remainder has a rate of 1.25%. I’ll point out again that homesteads valued at more than $414,000 do not get any value excluded.
Non-homesteaded residential property has a rate of 1.25%. Commercial and industrial property has a rate of 1.50% for the first $150,000 in value, and 2% of the value above $150,000.
There are other classifications, but this should cover the majority of properties. Generally speaking, residential property has class rates between 1.00% and 1.25%.
So many numbers, can you give some examples?
Let’s imagine our jurisdiction that has a tax capacity rate of 50%. How does that impact various properties?
Let’s use a homesteaded home valued at $600,000 as an example. Because the value of this home is so high, it does not benefit from the Homestead exclusion, the taxable value is $600,000. Since it has two class rates, we need two calculations to determine the tax capacity. The total tax capacity of this property would be ($500,000 x 1.00%) + ($100,000 x 1.25%), or $5,000 + $1,250, for a total tax capacity of $6,250. The $100,000 is the value of the property over $500,000. Now we multiply the tax capacity by the tax rate, or ($6,250 x 50%) to get a tax bill of $3,125.
If we go back to our median Minneapolis home, valued at $190,000, and treat it as homesteaded, we only have one calculation, because the taxable value does not exceed $500,000. To calculate its tax capacity we take its taxable market value of $169,860 (not its actual market value of $190,000!) and multiply it by 1.00%, giving a taxable value of $1,698.60, which gets rounded to $1699. Then we can multiply this by 50%, or ($1699 x 50%) to get a tax bill of $850.
If these homes were not homesteaded, the calculations are simpler. Non-homesteaded residential property has a class rate of 1.25%. The tax capacity of the $600,000 home would be ($600,000 x 1.25%) or $7,500. The tax capacity of the $190,000 home would be ($190,000 x 1.25%) or $2,375. Remember that since these homes are not homesteaded the full market value is taxable. Multiplying both of these tax capacities by the tax capacity rate would give tax bills of $3,750 and $1,188, respectively.
Let’s also imagine a restaurant with a value of $500,000, which is a commercial property. The tax capacity of this property would be ($150,000 x 1.50%) + ($350,000 x 2.00%) or $2,250 + $7,000 for a total tax capacity of $9,250. Applying the tax capacity rate of 50% to this property would yield a tax bill of $4,625.
What about all those other jurisdictions?
Remember earlier I said that my property was taxed by seven different jurisdictions. As a property in the city of Minneapolis, its tax capacity was charged at a rate of 62.437% for the city of Minneapolis. However, the total charge was 137.314% for all jurisdictions. The Hennepin County 2016 Final Tax Rate Card shows the tax capacity rate for each jurisdiction as well as the total tax capacity rate. As my property is in the City of Minneapolis (Municipality 01), Minneapolis School District (Special School District #1), and the Middle Mississippi Watershed District (District 6) my total tax capacity rate was 137.314%.
Would you like to know more?
Next week in Part 3 I’ll try to explain some of the implications of our property tax system, as well as answer burning questions like “Do renters pay property taxes?” and any other questions that come up in the comments.
Great post! It seems clear that a property’s use determines taxable value, versus how it’s zoned. This came up during a meeting at the Mac Groveland Community Council’s Housing & Land Use meeting last night and the St. Paul PED guy said he would research the issue. But I think you’ve provided the answer above.
Exactly, property taxes are based on the use, not the zoning.
I remember a number of years ago a rezoning issue here in Minneapolis where the zoning was for a duplex but the homeowner had put in a 3rd unit. They’d assumed everything was fine because they were taxed as a 3 unit building, but there’s basically no coordination between property tax assessment and zoning.
Great post! Can’t wait for part three!
This may be outside the scope of the series, but we hear about all sorts of “tax reform”. Sales tax reform, income tax reform, etc. Maybe some point we could have a neutral discussion of any sorts of property tax reforms past, proposed, or imagined.
For instance, I have a vague recollection there was a state property tax reform a couple decades back (in the early 80s?) regarding school districts where school districts had a small percentage of school district property tax go to the state to be distributed to the poorest school districts generally as a way balance out the wealth advantage that wealthy districts would naturally accrue.