Taxes are the bane of many individuals and businesses, and some taxes are worse than others.

Making things more complicated, some taxes are more arcane than others, too.

So it goes with the ad valorem tax.

What Is an Ad Valorem Tax?

This tax, which is derived from the Latin term for "according to value," is a percentage based on an asset, commodity, product or something thing of value.

Like virtually all taxes, the ad valorem tax is levied by the government, in this case, the state and local governments in the U.S. Government tax offices calculate the ad valorem tax based on a percentage of the perceived value of the entity being taxed.

A good example of the ad valorem tax is a local property tax, which is assessed annually on the value of an owner's residence and property. Homeowner's property taxes are levied by local governments and could even be levied by county governments, municipalities, or local school districts.

The ad valorem tax on real estate is placed on the following property forms:

  • The land the property sits on
  • The building or the home itself
  • Any other structures on the property (like a barn or guest cottage.)

An ad valorem tax cannot be placed on possessions of the property dweller on-site, like a fence, livestock, or a garden. That protects a property owner who likely already has paid taxes on a tool purchased, like a hammer, or a shed that is attached to the property.

In many local municipalities, however, ad valorem taxes can be placed on motor vehicles on a property, like the family car or even a tractor on a farm.

It's worth noting that while property taxes comprise the bulk of government-instituted taxes, other forms of ad valorem taxes may come into play.

For example, an ad valorem tax may be levied on goods purchased overseas and brought home to the U.S. In that scenario, ad valorem taxes are usually included in the amount of the purchase. (Like when someone buys a bottle of wine at an airport duty-free shop.)

How Are Ad Valorem Taxes Calculated and Assessed?

While ad valorem taxes can be assessed at the discretion of the taxing office, most are levied once a year - usually on or around Jan. 1. That tax is assessed as an annual tax levy, to be paid once yearly.

Ad valorem taxes may also be assessed on the immediate purchase of a property, usually via a value added or property sales tax. It can also be handed down in the event of an estate transition, when property ownership changes hands in a trust or inheritance deal.

Once the property is purchased, future ad valorem taxes may be levied on a recurring basis, like once per quarter or, in the example above, once per year.

Structurally, ad valorem taxes are calculated as a percentage of the assessed property or entity, with fair market value deployed as the value assessment benchmark.

What exactly is fair-market value?

In a few words, it is the price a party is willing to pay to a seller for (in this case) a piece of property. Fair price must be agreed upon before a deal can be closed, and is generally deemed to be the price a knowledgeable buyer or seller will pay, or be paid, for the property.

Fair market isn't just pulled out of thin air. Usually, county, state or local governments will call on a trusted property appraiser to place a value on a property, and that estimate may come from a single evaluation or in regular visits over a specified period of time (like one year).

When the government and the appraiser set out to determine a property value before levying an ad valorem tax, the following guidelines are used to establish a taxing calculation:

  • The actual cost of the property and any depreciation on the property since the date it was purchased by the owner.
  • The use of comparable real estate value in homes, buildings and properties located near the taxable property in question. In real estate lingo, the term is known as a "comp."
  • The amount of use on the property (i.e., the more the property is used, like for a farm or a multi-family apartment, the higher the tax, in most cases.
  • The size of the property. It's no surprise that the larger the property, the higher the ad valorem tax.
  • The estimated net income raked in by the property when using that property.

Once the appraiser has filed his or her evaluation of the property and government tax assessment, the governing agency can now levy the ad valorem tax, and can duly send it off to the property owner in the form of a letter (sometimes classified) via mail.

The property owner has a fixed amount of time to pay the tax in full - usually 30 to 90 days.

If that property owner wishes to dispute the tax amount, which is a fairly common occurrence, he or she can do so via a valuation dispute. Appeals start at the local level and can move on up to the county or state level for resolution. In some cases, a tax court is needed to resolve thornier ad valorem tax disputes.

If you're a property owner - especially the owner of a large, commercial use property, it's highly advisable to consult with a trusted tax attorney to ensure you're being treated fairly in an ad valorem tax assessment.

All taxes are, after all, unique to the taxee, so having a seasoned professional on one's side can ensure a more level playing field - even when Uncle Sam is sitting on the other side of the tax assessment table.

Examples of an Ad Valorem Tax

Each property is different and each ad valorem tax is unique to the particular property in question.

Still, it's worth assessing a typical ad valorem tax situation, for the purposes of better understanding how these tax deals go down.

Let's say a property is sized out at 3,000 square feet and is valued at $750,000. What's included in an ad valorem tax assessment in this instance is the dollar value of the home, at $750,000.

What's not included in the tax assessment is the actual size of the home, at 3,000 square feet.

If you're a property owner or someone who might come across an ad valorem tax after an inheritance or simply after purchasing a product and bringing it home from the airport, getting to know and understand the ad valorem tax is strongly recommended.

After all, every dollar you can save on an ad valorem tax is one dollar less going into the pockets of the government - and that's a win-win in any personal financial scenario.