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Types of Tax Abatement Strategies

Freeze Real Estate Tax Assessments

Freezing real estate tax assessments, particularly assessments on older buildings that provide homes for many low- and moderate-income families, is one of example of how jurisdictions can use tax abatements to encourage the preservation of existing affordable housing. Owners who lease out moderately priced older units may not be able to earn sufficient income from the rent payments to keep up with needed repairs and modernization. This is especially true during difficult economic times when homeowners and landlords defer needed maintenance projects to cover other expenses, like the mortgage. Declining home values also limit the amount of home equity that can be tapped for home repairs and improvements. To prevent the loss of these aging homes, some communities grant tax abatements to property owners who undertake qualifying repairs and upgrades that increase the assessed value of the property. By freezing real estate tax assessments at the pre-improvement level over a designated period (generally five to fifteen years), tax abatements can make completing the necessary repairs financially feasible.

Some communities apply the “but for” test as a condition for granting abatements, meaning that repairs or upgrades would not be made “but for” the tax abatement. Without this incentive, necessary upgrades may be deferred indefinitely, potentially leading to (a) continued deterioration of the property; (b) renovation of the property to a sufficiently high standard that allows higher rents to be charged; or (c) sale of the property to a buyer willing to undertake the needed rehabilitation. All of these scenarios would eventually result in the loss of affordable rental homes.

To ensure properties remain affordable, some jurisdictions condition tax abatements on an agreement that the owner will rent to families with incomes below a specified level for the period of the abatement. Supporters of these restrictions suggest that failure to impose rent limits essentially subsidizes the development of market-rate and luxury units, resulting in forgone revenue and minimal public benefit. If affordability is a primary objective, attaching affordability requirements will help to ensure that the abatement will succeed in advancing this goal.

Lower Tax Rates for Community Revitalization

Tax abatement programs can be selectively offered in neighborhoods that have a large number of vacantabandoned, distressed or foreclosed properties in order to stimulate new construction or rehabilitation. Some cities also offer targeted tax abatement programs to prompt new development or conversion of buildings to residential uses in downtown districts and other areas that have an inadequate supply of housing (or could accommodate additional residential growth).

Similar to tax increment financing, eligibility for these programs is limited to developers and property owners in designated zones and should be subject to the “but for” test. In Washington, D.C., for example, several developers retroactively requested tax abatements on properties that were built as part of larger neighborhood revitalization strategies. This highlights the importance of carefully crafting the criteria for tax abatements, especially as it relates to the “but for” test to determine what development would and would not occur but for the tax abatements.  It also highlights the need to plan for the consequences of a successful tax abatement policy and the impact it might have on communities and neighborhoods.

Limit Real Estate Tax Assessments for Rent- and Resale-Restricted Properties

Residential real estate tax assessments typically are based on the market value of the “highest and best use” of the property, rather than the actual usage. For owners of rent-restricted properties, this valuation method can present an obstacle to sustained participation in housing affordability programs. Unlike the owners of unrestricted market-rate rentals, who can charge higher rents to cover increases in their operating costs, affordable housing providers have limited ability to raise rents when their real estate tax bills increase.

Landlords who accept Section 8 Housing Choice Vouchers face similar limitations on the rents they can collect from voucher-holding households. As a result, rental property owners in high-cost areas may be reluctant to participate in these voluntary programs or to renew the contracts that guarantee long-term housing affordability but compromise their ability to manage rising costs.

To address issues related to tax valuation, some communities offer tax abatement programs that provide reduced assessments and real estate tax rates to providers of affordable rental homes and adjust valuation methods for resale-restricted properties. For example, Illinois’ Housing Choice Voucher Tax Savings Program encourages landlords to accept applicants holding vouchers by providing a 19-percent reduction in the equalized assessed value of units leased to voucher holders. In keeping with the program goals of promoting economic diversity and deconcentration of poverty, eligibility is limited to areas where the poverty level is below 10 percent, and landlords may only claim the tax abatement on the greater of (a) two units per property, or (b) 20 percent of all units. Several jurisdictions promote the program, including the City of Chicago, Cook County and DuPage County.

Another example relates to the value assessment of properties created with the Low-Income Housing Tax Credit. These assessments are often limited to reflect the unique nature of those properties in terms of use and resale. Some jurisdictions, such as the State of Washington’s Department of Revenue, have released official guidance that strongly suggests that properties with restricted rents be assessed accordingly. This reduces the burden on property owners who have committed to creating and preserving affordable units in their communities.

In 2002, the state of Illinois also created a special real estate tax classification intended to preserve the availability of rental homes made affordable through project-based Section 8 contracts. The Class S incentive grants a lower real estate tax assessment rate to the owners of multifamily rental properties who renew project-based Section 8 contracts through HUD’s Mark-Up-To-Market program. In exchange for an agreement to participate in the Section 8 program for a five-year period, eligible units are taxed at only 16 percent of market value, a 52-percent reduction in the real estate tax assessment level ordinarily applied to multifamily residential real estate when the legislation was passed (33 percent). 

Resale-restricted properties in the District of Columbia are subject to a special assessment process under which taxes are calculated based on the amount the current owner originally paid for the property, rather than its assessed market value. The real estate tax assessment for properties in this category is determined by (1) setting the base assessed value of the property equal to the amount the current owner paid for it, excluding forgivable loans and other assistance that is unlikely to be repaid; and (2) annually adjusting the base assessed value for inflation using Bureau of Labor Statistics figures for the area. To be eligible, properties must be subject to resale restrictions imposed by either the U.S. or D.C. government, or a tax-exempt organization, that limit resale to low- or moderate-income buyers for a period of at least five years.

Limit the Rate by which Real Estate Tax Liability can Increase

Communities that see significant home price increases also typically see rapidly escalating real estate property taxes. Even if home values decline in these neighborhoods, property taxes may not reflect the decline due to long-term assessment periods. Households with fixed incomes may be unable to find room in their budgets to pay for tax increases. In response, many communities have developed tax relief programs targeted to disabled and elderly homeowners. In some cases, these programs freeze the assessed home value to prevent dramatic tax bill increases. Other jurisdictions freeze or reduce the overall tax bill or offer a credit on taxpayers’ income taxes to reduce the real estate tax burden.

In many communities, particularly in high-cost areas, programs are not limited to senior households. Some state and local programs limit increases in real estate tax bills to mitigate the impact created by rising property values. Other programs provide relief by limiting the real estate tax liability of low- and moderate-income households.

Through its Homeowner’s Property Tax Credit Program, the state of Maryland helps low- and moderate-income homeowners manage rising real estate taxes by limiting tax liability to a fixed percentage of household income. When eligible households receive a tax bill that exceeds this fixed percentage, the state will issue credits to pay for the difference. Real estate tax limits are based on the following percentages:

Income Tax Limit (percentage)
Up to $8,000 0 percent
First additional $4,000  4 percent of additional income
Second additional $4,000  6.5 percent of additional income
Additional income above $16,000 9 percent of additional income

Source: Homeowners’ Property Tax Credit Program, Maryland Department of Assessments and Taxation

To qualify for the program, combined gross household income and net worth (not including the value of the property) cannot exceed a set threshold. A retired worker who meets these qualifications and receives monthly Social Security benefits of $1,000 ($12,000 each year) would be responsible for up to $160 in annual real estate taxes (0% of the first $8,000 and 4% of the first additional $4,000), and would receive a credit on a tax bill exceeding that amount. In addition, some counties in Maryland enhance the program by offering their own supplemental credits.

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