Buying a Fixer-Upper? Beware This Property Tax Pitfall

You could get stuck with a higher tax bill.

If you're in the market for a new home, you're probably aware that property values are sky-high right now. And mortgage rates have also risen a lot this year. That means you could end up having to spend a lot of money on a mortgage for a new home.

But you might snag a deal on your home's purchase price if you're willing to buy a fixer-upper. Homes that aren't in the best of shape don't tend to command the same higher prices as updated ones. And while buying a fixer-upper could mean having to sink a bunch of money into renovations, the upside is that you get to put your own stamp on your home.

But if you're going to purchase a fixer-upper, it's not just renovations you'll need to budget for. You may also need to plan on higher property taxes than you start out with.

Why your property tax bill could climb

Property taxes are calculated by taking a home's assessed value and multiplying it by whatever local tax rate applies. The work you do on a fixer-upper won't impact the latter point -- your tax rate is set by local government and has nothing to do with your home versus any other home in your neighborhood.

But the work you do on a home could change its assessed value. And that could, in turn, cause your property tax bill to rise.

So, imagine you buy a home that's in disarray or hasn't been updated in years. At the time of your purchase, your home might be assessed at $200,000. Meanwhile, if your local tax rate is 1.5%, that leaves you with an annual property tax bill of $3,000.

But let's say you decide to pretty much gut that home and improve it substantially. You might put in a new kitchen, redo the bathrooms, rip out old flooring and replace it with hardwood, and finish the basement.

All of that work could easily double the value of your home so that at its next assessment, its value is determined to be $400,000. Suddenly, you're looking at a $6,000 property tax bill instead of $3,000. And that's a big expense to factor into your budget.

Look at the big picture

Buying a fixer-upper might seem like a great deal. And in some cases, it can be.

Imagine you're able to snag a home that needs a lot of work for $200,000 while updated properties in that area are being sold for $500,000. If you're very handy and you're able to do a lot of renovations yourself, you might manage to fix up your home for $200,000 and spend $400,000 in total, thereby saving yourself $100,000.

But while you might reap certain savings in the course of buying a fixer-upper, don't forget about potential property tax surprises down the road. The initial property tax bill you're presented with will be based on the condition and value of your home at the time you buy it. Any time you make home improvements, your property value could climb and your tax bill could follow suit. It's best to not max out your budget on a home so you have wiggle room for that possibility.