Understanding the difference between an ad valorem tax and, for instance, a specific tax, is valuable as you make financial choices like buying a house or another expensive item that has tax applied.
Definition and Examples of Ad Valorem Taxes
Ad valorem taxes comprise many of the state and local taxes in the U.S., as well as a variety of taxes charged abroad. These taxes are levied based on a percentage of an item's value, such as a 6% sales tax added to the price of a new hairdryer you purchase, for example.
When a country chooses a flat rate for an import tax or a value-added tax (VAT) that is issued when someone brings an item into or out of the country, that is often an ad valorem tax. The most common type of ad valorem tax in the U.S. is property tax—one of the main sources of revenue for local governments at the county or city level.
One of the complex elements of ad valorem taxes is that not everyone agrees on the assessed values assigned to their property. To decide your tax rate, an official assessor evaluates your property—similar to how an appraiser would evaluate it during a home sale process—and reaches an assessed value. If the property is believed to be worth more now than in the past, your tax bill will rise.
While income taxes in the U.S. are progressive, meaning they levy higher percentages for higher income brackets, many ad valorem taxes are a set rate.
A community might charge a flat 1% property tax based on an assessed property value that is updated every few years, for instance. Many communities use these property taxes to pay for local government functions, as well as for public schools.
There are, however, ad valorem taxes that are only assessed at a certain value or higher. For instance, the U.S. federal estate tax is an ad valorem tax on the value of the estate but is levied progressively. This means higher tax percentages are owed depending on how much of the estate's value is above the exemption rate, which was $11.7 million for individuals in 2021.
An example of a tax that is not ad valorem would be a specific tax, such as 50 cents per gallon of gas. In this case, the assessed value of the gasoline wouldn't impact the total cost of the tax.
How Ad Valorem Tax Works
Some ad valorem taxes will be assessed at different, recurring frequencies. For instance, you are charged sales tax just once when you purchase a product like the hairdryer mentioned. Property taxes, on the other hand, are often levied annually or quarterly on the same item.
Assessors do not always tax the market value of a property. For instance, West Virginia's State Tax Department states that the assessed value is actually 60% of what the fair market value would be.
To know what percentage of the fair market value your property tax is likely to be, you'll need to check with your state or local jurisdiction.
Consider an example. If you purchased a home and the current assessed value was $100,000 for a 1% property tax, you'd be paying $1,000 a year.
If your area went through an economic downturn right after the assessment, you would continue paying that $1,000 a year until the next assessment, even if your home was worth less if you attempted to sell it.
If you were in Ohio, for example, it takes six years before reassessment, which means you could be paying your $1,000 bill even if your property value plummeted. Other states have different requirements for how often a new assessment will occur.
That being said, your home also could increase in value. If this occurs and it is time for reassessment, some states and local jurisdictions send a notice to let you know that the assessment raised your home's value. If your assessed value rose to $120,000, for instance, you'd be given notice so that you could prepare for your property tax bill to be $1,200 that year.
Do I Need To Pay Ad Valorem Tax?
Some ad valorem taxes are assessed at the time of sale, like sales tax. These taxes are part of your bill, making it easy to know they are due.
Individuals who rent rather than become homeowners only pay indirectly when it comes to property tax. While landlords do have to charge rent that covers their expenses, you won't have to pay your own ad valorem property tax bill because that burden is on the landlord.
Beyond housing, other properties, including cars and boats, may also have some ad valorem taxes on them. However, as with other kinds of sales tax, they will be calculated and charged by the seller in many cases.
How Much Are Ad Valorem Taxes?
Ad valorem taxes can vary widely, from Tennessee's combined state and local sales tax of 9.55% to an average of less than 1% property tax in Hawaii. The ad valorem tax varies between counties, hence the average.
In terms of dollars, however, a property owner in Hawaii might end up paying more in taxes than a property owner in another state with a higher rate because Hawaii's property values are often very high.
To calculate the impact of an ad valorem tax on your budget, you'll need both the effective rate of the tax and the value to which it will be applied, such as your average spending each month for a sales tax or your home's assessed value.
- Ad valorem, which means "according to value" in Latin, refers to the fact that a tax is levied as a percentage of a property's value.
- Ad valorem taxes can be assessed once when an item is first purchased or brought across country lines. They also can be a periodic tax, as with real estate.
- Ad valorem taxes in the U.S. are often levied at the state, county, city, or school district levels.
- For real estate like homes and land, an official assessor will periodically reevaluate how much the property is worth for tax purposes, raising or lowering your tax bill as a result.