Homestead Credit Repeal Shifts Tax Burden Onto Apartments, Businesses

Minnesotans will see a tax hike, after all.

As part of the budget deal that ended the Minnesota state government shutdown, legislators repealed the market value homestead credit. This will lead to bigger property tax bills—but not necessarily for those who once received the credit.

Eliminating this tax break for homeowners on their primary residence will restore some money to cities that had been lost through cuts to Local Government Aid.

Homeowners who lost the credit—among the poorest in the state—will get a break on their home value to compensate for the loss of the credit. This will force apartments and business properties to pick up the slack.

The result is a landscape with some winners, some losers and many still trying to understand exactly what this means for their communities.

“I think confusion is reigning right now,” said Gary Carlson, director of intergovernmental relations at the League of Minnesota Cities. “It is difficult to get your arms around this tax burden shift.”

Winner: Metro-area city governments

The market value homestead credit has chaffed at cities for several years—in part because it is a state-mandated reduction in local government taxes. Cities levied a specific amount of money but collected less than the total levy because of the credit.

This year Golden Valley lost $369,240, said Sue Virnig, finance director for the city. It lost the same amount in 2010.

The state originally made up the difference between the levy amount and the tax credit reduction. But it pared back reimbursements to local governments as its own budget got tighter. Many cities saw reimbursement cuts nearly every year over the past decade, Carlson said. Every city had some cuts during the past two years. 

Statewide, cities have been reimbursed at just 15 cents on the dollar, Carlson said. Cities had to try to guess how much they’d get and levy a higher amount to make up for the shortfall in state money.

“The program that is now being sunsetted has kind of been a farce over the past couple years, to put it bluntly,” Carlson said.

Cities had a particular incentive to repeal the credit this year because many stood to lose Local Government Aid. Ending the homestead credit was a sort of consolation prize for $102 million in Local Government Aid cuts.

“It was a struggle to keep the LGA that we did,” said Preston Rep. Greg Davids (R-District 31B), speaker pro temp and chairman of the House Taxes Committee.

Golden Valley hasn’t received state aid "since at least 2001," according to Virnig.

Uncertain: Homeowners who got the credit

Prior to its repeal, the maximum credit peaked at $304 for a $76,000 home—declining from there until it hit zero for homes worth $413,778 or more.

Lawmakers didn’t want to simply repeal the homestead credit—that would be a de facto tax hike on those who could least afford it—so they drafted a formula to exclude part of a home’s value from taxation.

That $76,000 home will now be taxed as if it were a $45,600 home. The actual tax bill for each property owner will vary depending on many variables—the size of the community’s levy, the size of the tax base and how many property owners once received the credit.

One thing is clear: The elimination of the credit will have less impact on these homeowners than it otherwise would.

Losers: Those who didn’t get the credit

The repeal of the tax credit automatically puts millions back into local levies for 2012, and someone has to pick up the $261 million tab. The only properties left to do so are apartments and business properties.

The exact effects depend on the type of tax base a community has.

If a city has few homesteaded properties, the other properties won’t have many extra costs to absorb. A city with many business or apartment properties will have more properties to share those costs. But communities with many homesteaded properties and few businesses or apartments will see significant shifts in the tax burden—from the poorest of property owners to the wealthiest.

A House Research Department simulation predicts that metro-area homesteaded properties will see a 4.1 percent increase in their property tax burden. Non-homestead homes will see a 6.1 percent increase and apartments will see a 6.8 percent increase.

The burdens are much more equitable in the southwest metro. Homestead tax burdens would grow by 2.9 percent, non-homesteads would grow by 3.2 percent and apartments would grow by 3.5 percent. Patch didn’t include business property changes because, unlike other properties, they also pay a state property tax, which didn’t change this year.

Davids represents a district in which every community benefits from either local government aid or county program aid. He expected the shifting tax burden.

“We knew that. We knew that was a concern,” Davids said. “Anytime anyone’s given the wrong end of a shift, it concerns me.”

The state faced a gaping deficit and had to find some way to close the gap, he said. Repealing the homestead credit was a good way to compensate communities for the other money they lost—specifically Local Government Aid.

“We had X number of dollars and had to stretch them as far as we could,” he said.

Davids doesn’t consider the overall package a tax increase, though. He noted the same tax bill that repealed the homestead credit also included tax cuts for data storage centers and preservation of a renters credit.

“By the time you add them all up, I think we’re in pretty good shape,” he said. “I’m actually very excited about what came out of the special session and the tax bill.”

He and other Republicans also argue that local governments don’t have to increase property taxes at a dollar-for-dollar ratio to the state money they lost.

Even though cities could conceivably cut their levies by the same amount as the homestead credit money, many are already struggling against rising costs and drops in outside money—particularly those that receive Local Government Aid.

“When the state withdraws $261 million from the property tax system, yeah it’s a tax increase,” Carlson said. “$261 million in city services is not going to simply evaporate.”

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How could property values change?

Changes from the new tax bill will vary from taxing district to taxing district, and communities are still trying to wrap their arms around the effects. The House Research Department ran a simulation of what changes from 2011 to 2012 could look like in certain regions. The simulation takes into account many property tax variables—including changing values, LGA cuts, tax increment financing, fiscal disparities and the market value homestead credit repeal. 

Commercial /Industrial (high value)

SOURCE: House Research Department

Why is commercial/industrial lower?

The rates above can make it look like commercial and industrial properties don't have it so bad. In reality, their tax growth is masked by two factors. To see the true effects on businesses, apartments are perhaps the best barometer. Here's why:

State taxes: Commercial and industrial properties pay a state property tax that homes, apartments and other types of properties don't. This tax is about a quarter of their total property tax and did not change this year. That reduced the percentage their total burden grew even though their share of local taxes grew more rapidly than homestead properties. Their tax bills are also much higher. A $300,000 commercial or industrial property would pay $9,400 in a hypothetical southwest metro community, according to the simulation. A $369,400 homesteaded property would pay $5,007.

Fiscal disparities: This is a revenue-sharing program that seeks to spread the benefits of development across the Twin Cities metro. These calculations lag a year, so burden shifts for businesses will appear in 2013.