Ad Valorem Tax: 3 Examples of Ad Valorem Taxes

An ad valorem tax is a tax that’s levied, usually on a local level, on a physical asset based on the item’s assessed value. It isn’t impacted by a property’s weight, size, or quantity.

Local government entities, such as counties or school districts, generally levy ad valorem taxes, and this tax may serve as its primary source of income. The tax’s name comes from the Latin phrase ad valorem, which means according to value.

The main types of ad valorem taxes include:

1. 1. Property tax: Tax authorities may levy ad valorem property taxes against personal or commercial properties or improvements made to a property, such as an addition. They typically assess taxes on a periodic basis, and the tax follows the property regardless of ownership.
2. 2. Sales tax: Sales tax is a one-time transactional tax that’s built into an item’s price or charged at the time of purchase. The seller typically collects the tax and forwards the payment to the applicable tax agency.
3. 3. Value-added tax: Value added through business services or labor may incur an ad valorem tax. A VAT (typically paid by the consumer) is levied against the value these services add to a product. A VAT is usually paid at each stage of an item’s production.
4. 4. Title ad valorem taxes: Some states charge TAVTs—one-time taxes paid when a motor vehicle is titled.

Ad valorem taxes are often considered real estate taxes. However, numerous types of personal and real property are subject to ad valorem taxes, including:

• Land and property: This includes land, buildings and other structures, as well as other major personal property.
• Improvements: Ad valorem taxes can be applied to improvements made to a property or structure.
• Vehicles: This can include motor vehicles, such as cars, RVs, and boats.

An ad valorem tax typically represents a percentage of a property's assessed value. Before the tax authority can calculate the tax, it must determine a property’s fair market value, which is defined loosely as the price a knowledgeable, willing buyer and a willing seller would find reasonable. To determine the fair market value, a tax assessor may hire professional appraisers, who may order an inspection of the property as part of the valuation.

Several factors may contribute to a property’s value, including the cost of purchase, comparable market data, current or intended property use, projected income from property use, and estimated depreciation. Assessments used in determining ad valorem taxes are typically calculated annually as of January 1. Property owners who disagree with the ad valorem assessments may file an appeal with the tax authority or a relevant tax court.

Once the tax assessment is complete, the tax authority generally calculates the amount of tax using the millage rate in the tax district, which equals $1 of tax for each $1,000 of the assessed value of the property. Essentially, 30 mills equals a 3 percent tax rate, or $30 for every $1,000 of property. The rate of taxation may depend on whether the property is classified as residential, commercial, industrial, or agricultural.

Tax authorities may collect ad valorem taxes when a property changes hands, such as during a real estate transaction or an inheritance. However, most tax authorities impose ad valorem taxes annually, quarterly, or on another regularly scheduled basis. Some properties may be subject to ad valorem taxes from more than one jurisdiction. For example, a county and school district may both levy ad valorem taxes on a building, each with different collection dates.

Ad valorem taxes may take many forms. The following examples highlight several ways these taxes may be applied:

1. 1. Residential property tax: Tax assessors have valued a family home at $100,000 as of January 1. The area's current property tax rate is 3.5%. The ad valorem property tax would be calculated at 3.5 percent of $100,000, or $3,500. If the homeowners file for a homestead exemption, which shields the first $50,000 of the value, they would only pay taxes on the remaining $50,000, which amounts to $1,750.
2. 2. Sales tax: A consumer purchases a laptop at a major retailer for $500. The county's sales tax rate is 7 percent. Sales tax on the laptop is $35, which is 7 percent of $500, for a total purchase price of $535.
3. 3. Value-added tax: A components manufacturer purchases the raw materials to make flashlight parts, paying the seller $1 for each unit plus a VAT of 10 cents, which is sent to the relevant tax authority. This manufacturer then sells the completed components to a flashlight manufacturer for $2 per unit, plus a VAT of 20 cents. The seller keeps 10 cents per unit as reimbursement for the VAT it paid to the raw materials dealer and sends the other 10 cents to the tax collector. Once the flashlight is made, it’s sold directly to consumers via a website for $3 plus a VAT of 30 cents. The seller keeps 20 cents per flashlight as reimbursement for the VAT it previously paid. The rest goes to the tax authority.

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