One way to build wealth over time is by investing in property. However, that can be expensive. By the time you figure the actual cost of buying the real estate, and then add in property taxes, you could be hard-pressed to turn a profit.
However, there are ways to reduce your costs when buying property. One of those ways is through tax abatement. Depending on where you live and whether you qualify, you might get a reduction in property taxes, making your purchase a little more affordable–and potentially more profitable.
Here’s what you need to know about tax abatement.
Table of Contents:
What is a Tax Abatement?
Tax abatement is a way for governments, often cities or states, to reduce property taxes in a certain area. In many cases, tax abatement areas are those that a government entity hopes to revitalize. They hope that by offering an abatement, they can attract residents and investors to a specific area.
A tax abatement can be residential or commercial. It’s up to the governing authority to decide on its goals and to figure out how to offer abatements that result in the desired outcome.
In most cases, a tax abatement is temporary, so at some point, full property taxes will be levied against the property. Additionally, the governing authority can choose to revoke the abatement at any time. It’s important to pay attention to the terms of the abatement before moving forward.
Why are Tax Abatements Offered?
In general, there are reasons that tax abatements are offered by local governments or states. In many cases, they find a net benefit from encouraging development in areas that have succumbed to blight or other problems.
If a tax abatement will encourage people to move into an area or investors to work on commercial projects, the general increase in economic activity and community investment can outweigh what’s lost through abatements. Plus, eventually, the abatement will come to an end and the authority can collect full taxes on a property that–hopefully–has increased in value and generates a higher rate of taxes anyway.
Who’s Eligible for a Property Tax Abatement?
Every governing authority has its own requirements for tax abatement. First of all, you might need to prove that you meet income requirements. Some abatements are only available to those with low- to middle-incomes. Your tax return can help provide your income. If you use a service like TurboTax, you should be able to get access to past tax returns and other documentation to prove your income.
In other cases, property tax abatement eligibility is related more to requirements to make improvements. You might be required to upgrade the property and make improvements. If you’re purchasing multi-family units for rentals, you might be limited to the number of units in the building. For example, a city might limit the units in a property to four if you want to qualify for an abatement.
Another common requirement to receive a property tax abatement is to make energy-efficient improvements. New residents or investors might need to install more insulation, upgrade windows or make other changes in order to meet the criteria.
Before you move into a home or an area with an abatement, find out if there are additional requirements. You need to be able to plan for any required upgrades and figure out if the property tax savings are worth the additional outlay of capital.
Finally, realize that there might be other restrictions that can impact your ability to qualify for a tax abatement. You might need to move into a neighborhood during a certain time period, be required to live in the property and use it as a primary residence or there might be a time limit placed on how long you have to make required upgrades.
Read the fine print before you proceed so you understand everything you need to know about the tax abatement.
Downsides to Tax Abatements
While a tax abatement can be a benefit to your bottom line, whether you’re looking for a primary home or an investment property, there are some disadvantages to keep in mind.
Often, a property tax abatement program is aimed at revitalizing blighted areas. As a result, you might have problems with the neighborhood. If the abatement requires that you live on-site, there are amenities you might be giving up.
Additionally, there are times where abatements are offered in areas with higher crime rates. You need to weigh the savings on property taxes against lifestyle considerations involved.
Tax abatements come to an end
Remember that a tax abatement isn’t usually forever. At some point, the abatement will end and you’ll have to pay the entire amount of your property taxes. You can run some scenarios using your tax preparation software to see where you stand. For example, you can change some of your inputs with H&R Block to find out how you might see an impact to your bottom line.
Property tax abatements don’t always eliminate taxes
While there are some tax abatement programs that completely get rid of property taxes for a set period of time in a localized area, not every program is the same. In fact, some programs only reduce your taxes.
It’s true that you can claim property tax you pay on your federal return if you itemize. However, for tax year 2019 and 2020, you can only claim up to $10,000 combined state and local taxes (including property tax) on your return. There are tax programs like TaxAct that can help you figure out whether it’s worth it to itemize. In some cases, your standard deduction might be worth taking, rather than relying on itemization.
You could lose the tax abatement for not keeping up with requirements
Finally, you could end up losing the property tax abatement if you don’t keep up with the requirements.
If there is an income requirement and you have to re-apply for abatement regularly, you could lose your discount if your income increases.
Additionally, if you fall behind on the property taxes you do owe, the governing authority might decide to cancel your abatement early and all your tax bills will be due. Another possibility is that you don’t complete the required renovations within the time period specified and lose your abatement that way.
Tax abatements are issued entirely at the discretion of the authority, so you have to make sure you’re in compliance. In some cases, the red tape might not be worth it.
A tax abatement can be a great tool for someone looking to get a break on the total cost of a property. If you’re a homeowner, you might be able to better afford a home without the worry of paying a higher property tax bill. As an investor, you might be able to develop a property and increase your profit with the help of an abatement.
However, it’s important to carefully consider the situation and run the numbers to see how much you’ll really benefit from a property tax abatement before you make your purchase. You also need to prepare for the future and have a plan to afford the property taxes when the abatement ends.