"Sticky" Property Taxes

Q: How long does a property tax hangover last?
A: Two years-plus

One of the sticking points, literally, for would-be Buyers of foreclosed properties is an unpleasant hangover from the erstwhile housing boom: bloated property taxes.

In today's, foreclosure-tinged market, it's not unusual to see homes listed for 30% or less of their assessed tax value (no, that's not a typo). However, even if the Buyer pays the dramatically lower, current list price, they'll temporarily be stuck paying taxes pegged to the older, inflated price.

When the property taxes do adjust lower, the drop is likely to be disappointingly small, given how cities calculate "assessed value."

Some examples illustrate the point.

In Minneapolis, a home assessed at $60,000 might owe about $1,000 in annual property taxes. A home that the city values at $200,000 would owe around $2,500. So, if you buy the formerly $200,000 house in foreclosure for $60,000, your property tax bill will be $1,000, right? Wrong, at least not for a few years.

While property taxes will certainly drop once a sale at a dramatically lower price is recorded, the drop is likely to be much smaller, and take longer, than many Buyers might reasonably expect.

"Bruised Apples to Oranges"

There are two reasons for that:

One. Property taxes can lag the market by two years.

By convention, Minneapolis property taxes are set each January 2 for the following year. That means whatever the city deemed your home to have been worth last Friday, is what you'll pay 2010 property taxes on. In turn, the value last week is based on comp's ("comparable sold properties") from the tail-end of 2008.

Depending on what the housing market does from here, it's certainly possible that late 2008 prices may not be so accurate two years from now. Or put it this way: the odds are pretty good that your 2008 property taxes, pegged as they were to 2006 prices, were artificially high.

Two. Municipalities like Minneapolis do not consider what Buyers paid for foreclosed properties to be fair market value (let that sink in for a minute).

That's because bank-owned homes -- foreclosures -- aren't considered "valid sales" for comp purposes.

According to Minneapolis, a valid sale doesn't involve duress. Because foreclosures by definition involve duress . . they don't count. (Interestingly, "short sales," whereby the bank agrees to reduce the mortgage balance owed, usually do count as valid sales -- at least that's what my contact in the Minneapolis Assessor's office told me).

As a practical matter, what that means is the city assessor must establish the foreclosed home's market value by comparing it to sales of nearby, non-foreclosed homes. Common sense suggests that such "bruised apples-to-oranges" comparisons might be a stretch, and skew the price of the foreclosed home upwards.

"Who are you going to believe . . .?"

Which is exactly what seems to be happening.

So instead of the $60,000 foreclosed home being reduced from the $200,000 assessed value to the actual purchase price -- $60,000 -- in practice the new tax assessed value is likely to be much higher. Depending on what's happening with the closest non-foreclosed home sales, the new, tax assessed value could be anywhere from $100,000 to $150,000.

It reminds me of one of my favorite New Yorker cartoons.

In the original version, the non-cheating spouse catches the cheating spouse "in the act." The cheating spouse protests, "who are you going to believe, me or your own lying eyes?"

In the updated version, the cheating spouse simply says, matter-of-factly, "believe me, it's not what it is."

Part 2: Property tax tips for foreclosure Buyers.