Winter 2014

MARKET REPORT
Understanding Texas Land Taxes
For many owners of real estate, property
taxes represent their largest single
property-related expense. Marketvalue
tax levies make no allowances for
inability to pay, assuming that owners have the means to meet their obligations.
That assumption applies to standard income producing properties. However,
landowners achieve much of their return in long-term capital appreciation
available to only defray taxes when they sell their land. When potential
development drives up land prices and recreational buyers compete for scarce
scenic amenities, values outpace the current income stream. Taxation based on
those values exceeds total property income becoming confiscatory. Texas has
twice taken steps to remedy this mismatch by basing taxes on current income
potential with a provision to recapture some of the capital appreciation return.
Landowners harbor many misconceptions about how this works. First, they
refer to “agricultural use or ag use taxation.” But, most often they really mean
“open-space” taxation. Both base taxes on an agricultural use value but there
are major differences between the two. Ag use refers to provisions included in
Article 8, Section 1-d of the Texas Constitution; open-space arises from Section
1-d-1 of that document. However, that extra “-1” makes a big difference. The
1-d provision predates 1-d-1 and specifically targeted farmers and ranchers for
relief from crushing tax burdens. Because it targets true agricultural producers,
the 1-d provision requires both the land and the owner to qualify. In general,
the land must have a history of agricultural use but the owner must also meet
strict requirements. Specifically, agriculture must be the owner’s primary
occupation and source of income meaning that he or she must earn more
income from agriculture than from any other single source. In practice, that
hurdle proved insurmountable for the vast majority of Texas rural landowners.
Few, if any owners actually use the “agricultural use value” 1-d provision.
Because of the stringent qualifications embodied in 1-d, Texans adopted
open-space tax regulations of 1-d-1. Forgoing the focus on occupation, those
provisions aimed to preserve open space land in the Texas countryside by
reducing an owner’s holding cost. The objective became an environmental
goal of preserving open space land and not protection for farmers and ranchers.
That change of focus eliminated the need to fixate on an owner’s income
meaning that only the land must qualify for 1-d-1 treatment. That makes a
big difference.
A transfer of 1-d land to a new owner triggers a rollback of additional taxes
designed to recapture part of the capital gain. Additionally, a 1-d rollback occurs
when an owner changes the agricultural use to a non-qualifying use. For 1-d-1
land, ownership changes do not trigger rollbacks; only changes of use cause
additional taxes. There are further differences in the two rollback provisions
that make the 1-d rollback somewhat less onerous than the 1-d-1 counterpart.
However, owing to the complicated income requirements, owners seldom or
never use Section 1-d, preferring the more readily available 1-d-1. So most Texas
acreage is taxed as open-space land not ag use land.
Both provisions provide substantial tax reductions to their owners. When nonland
owners realize the magnitude of those tax savings, they frequently lobby for
changes to impose higher taxes on landowners. These efforts tend to emerge
when Legislatures encounter over school tax policy confrontations. Landowners
fear that an urban-based Legislature eventually will eliminate open-space taxation
dramatically raising tax burdens for landowners throughout Texas. Further, they
anticipate that the resulting taxes will drive down land values defeating the
original revenue raising goals and destroying landowners’ wealth.
However, both of these provisions reside in the Constitution, so elimination
requires a vote of Texas citizens to amend those measures, a much more
complicated move than passing a bill. Perhaps more threatening, is the language
in 1-d-1 allowing the Legislature to specify how to calculate agricultural value.
Currently, the value is based on the net income land can generate in it’s qualifying
use capitalized at 10 percent. That means that native rangeland netting $4 per
acre after all expenses goes on the tax roll for $40 per acre. Conceivably, the
Legislature could change that capitalization rate to 5 percent without a vote of
the citizenry. Then, the income-based value shoots up to $80 per acre, possibly
doubling an owner’s tax liability.
Texas land taxation faces potential challenges as Texas confronts property tax
policy issues. Landowners should take steps to understand how the system works
now and how possible changes might affect them.
48 LandsofTexasMagazine.com