C.L. Coonrod & Company Article

Homestead Credits, Are They a Good Thing?

This 2006 article is out-of-date because the homestead credit rates have changed, but the general concept of the homestead credit is the same.

Also, one paragraph in this article has proved prophetic, even beyond our expectation. The sudden increase in the 2006 credit, followed by the sudden decrease in 2007, was one of the main causes of the property tax crisis, leading legislation to reform property taxes in 2008.

Although local government has been loudly blamed for property tax increases, the homestead credit rate had a much greater impact on tax bills than local government increases did, in practically every county.

Local officials cannot always be expected to be experts in the property tax system, but there are some things your constituents will expect you know. One is how the homestead credit works.

For many years, the State of Indiana has favored homeowners by granting homestead credits.

The credit results in a reduction of property tax paid by local homeowners. Specifically, the credit is a reduction of the tax bill by a certain percent for property that serves as a person’s principal residence.

Does that mean local governments receive less money? Usually, it does not. Generally, the State makes up the difference from its own treasury. How does it work? From the point of view of local government, the process is invisible. Local governments simply levy their taxes, same as if there were no credit. Meanwhile, the State sends each County Auditor enough money to cover the credit. The taxpayer pays the net tax bill, the State pays the credit, and the whole levy is sent to the local government.

Sound like a good deal for local government? Generally, it is. Local government levies the tax and receives the revenue, but local property tax payers pay only part of it. The State pays the rest.

There are also some options for local communities to institute additional homestead credits, financed from local option income taxes.

There is only one downside to the State-financed homestead credit, and that is when the State reduces the homestead credit rate.

For 2006, the State is increasing the basic homestead credit rate from 20% to 28%. That is good for 2006, which incidentally happens to be the year most Legislators are due for election.

The bad news is, the rate then drops back to 20% in 2007, the year municipal officials are due for election.

The impact of the homestead credit is complicated, and it will be different for each homeowner and locality. At the risk of over-simplifying a complicated process, the basic impact in 2006 and 2007 will be as follows.

Most homeowners pay their property taxes through a mortgage escrow. They will find the 28% credit in 2006 to be an unexpected windfall. They will have extra money in their escrow accounts, and their current taxes will be lower than before. That means the mortgage companies will make a double reduction in the escrow payment: one reduction will be made to account for the lower tax, and another will be made to account for the excess balance in the account. Mortgage-payers will be very pleased with their recalculated monthly payments in 2006.

Unfortunately, in 2007 the reverse will happen. The return of the homestead credit from 28% to 20% will seem like a tax increase. Escrow accounts will be under-funded. Mortgage companies will make double increases in escrow accounts: one increase to account for the higher tax and another to account for the insufficient balance in the account.

From the point of view of a homeowner, the tax increase in 2007 may appear to be more than 8%, even though local governments will not receive more money.

2007 also happens to be the year homeowners will feel the effect of assessment “trending.” In the long run, “trending” will smooth out the sudden changes that result from general reassessments. However, in the first year, the medicine may be as bad as the disease. Initially, trending itself will cause a one-time shift of tax burden from commercial to residential taxpayers.

The only good news for 2007 is that homeowners will receive an additional $10,000 deduction from their assessed values. For homeowners with moderate-priced homes, a $10,000 deduction may be quite significant. However, for homeowners with more valuable homes, it is not.

Roughly speaking, a homeowner with a value of $125,000 will find that a $10,000 deduction is worth at least as much as an 8% credit. However, for more valuable homes, the $10,000 deduction may not be enough to offset the loss of the 8% credit.

Meanwhile, the $10,000 deduction is bad news for property tax payers in general. Unlike the homestead credit, the State does not finance the deduction. Since there is no free lunch, someone has to make up the cost of the $10,000 deduction. One possibility is for local governments to forego the revenue. In practice, the more likely result will be that local governments will keep their revenues level, and tax rates will increase. Those who don’t benefit from the $10,000 deduction will simply pay more taxes in 2007.

If you have questions about this article, please contact us at: Coonrod@CoonrodCPA.com

Revised March 21, 2008.

This article is intended to provide information of general interest to local government officials in Indiana. The information is not warranted to be applicable or appropriate in particular circumstances. Local officials should consult competent professionals before acting on any information contained in this article. We are not attorneys. Advice of a legal nature should be sought only from qualified attorneys.

To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue code or (ii) promoting, marketing, or recommending to another party any transaction or matter addressed herein.