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The financial aspect of business ownership represents some of the biggest challenges simply because there are so many nuances to track. A physical property for your business adds overhead costs such as utilities, basic maintenance fees and rent or a business mortgage. Property taxes add another layer of complexity because they are a prepaid expense. Do you know how to add a property tax accounting entry for accurate records?
Property Tax Accounting Entry
A prepaid expense is paid for in an accounting period prior to the accounting period in which the benefit is received. Although you might not get any tangible or obvious "benefit" from paying property taxes, prepaid expenses are always considered assets. Because prepaid expenses span accounting periods, you'll need to balance your journals appropriately to avoid an overstated account at the end of the period, which can make a property tax accounting entry a little complex, but not unmanageable.
You'll be dealing with three accounts: your cash account in the balance sheet, insurance expense account in the income sheet, and prepaid expense account in the balance sheet. If you owe $1200 in property taxes for 2020, you'll pay it in advance by December 2019. Therefore, start by crediting your December 2019 cash account $1200 and debiting your insurance expense account $1200.
Now you need to add an adjustment entry by crediting the insurance expense account $1200 and debiting the balance sheet $1200 to prepaid expenses. Failing to do this will skew your income sheet and show an incorrect profit. Finally, for each month in 2020, you'll debit the income expense account by 1/12th of the prepaid property taxes as the "benefit is received". For this example, you'll credit the prepaid expense account $100 and debit the income expense account $100 each month for an accurate property tax accounting entry.
Who Has to Pay Property Taxes?
If you rent a commercial property, your landlord handles the property tax each year, but this doesn't mean you're not paying for it. Your landlord likely incorporated the property taxes in your monthly payment. However, take a look at your contract or verify this with your landlord if you're not sure. You don't want to be surprised with a hidden fee around tax time.
If you've taken out a business mortgage for your commercial property, the responsibility for filing and paying property taxes falls on your shoulders. As with all taxes, the amount you owe each year can be a significant lump sum, and unless you set aside money each month for taxes, you'll be scrounging to pay it each spring.
Don't back yourself into a corner. Learn how to account for property taxes and how to incorporate it in your regular budget so that it becomes just another expense to track, like a utility bill.
Determining Property Tax: Assessed Value
Property taxes are decided based on two factors: the property's assessed value and your local property tax rate, which is called a mill levy.
The property's assessed value is essentially how much it's worth for tax purposes but not necessarily the price for which you'd be able to sell the property if it were on the market right now. Therefore, it's important to look up what your local government has on record as your property's assessed value.
The Mill Levy
Once you know your property's assessed value, you need to multiply that amount by the mill levy. Here's where it gets a little tricky: The mill levy is different in each county. You'll need to visit your county's department of revenue website or give the office a call in order to get an accurate mill levy for your property tax accounting entry.
For example, if you own a brick-and-mortar store in San Francisco, California, your mill levy is 1.1801%, but if you live in Garden City, Georgia, the mill levy is much lower at 0.3756%. Let's say you owned a commercial property in both cities with an assessed value of $100,000. You'd pay $1,180.10 per year in San Francisco but $375.60 in Garden City. That's a big difference, so make sure your property tax accounting entry is accurate for where your business is located.
- Savannah Economic Development Authority: Property Tax
- City and County of San Francisco Treasurer & Tax Collector: Understanding Property Tax
- CrowdReason: Commercial Property Valuation For Property Tax: When To Bring In The Experts
- Business Insider: How to Calculate Your Property Taxes
- Patriot Software: How to Record Prepaid Expenses
- YouTube: Accounting Stuff: Accounting for Prepaid Expenses
- State of Connecticut, Office of Policy and Management. "Mill Rates." Accessed Jan. 22, 2020.
- Maine Revenue Service, Department of Administrative and Financial Services. "Homestead Exemption FAQ." Accessed Jan. 22, 2020.
Cathy Habas specializes in marketing, customer experiences, and behind-the-scenes management. Cathy has contributed to sites like Business and Finance, Business 2 Community, and Inside Small Business. She served as the managing editor for a small content marketing agency before continuing with her writing career.