What Are Impact Fees and How Do They Work?

An impact fee is a one-time charge imposed by a local government on a new development project to fund the public infrastructure it requires. These charges are a way for municipalities to manage the financial pressures of population growth without placing the entire burden on existing taxpayers. This mechanism ensures that new development contributes to the cost of the expanded services it necessitates.

The Purpose and Scope of Impact Fees

The guiding principle behind impact fees is that new growth should pay for itself. This approach shifts the financial responsibility for new infrastructure from the community at large to the specific developments creating the demand. Instead of funding expansion projects through broad-based property tax increases, municipalities can target the costs more directly.

Impact fees are designated for capital improvement projects that add capacity to public systems. Common examples include:

• The construction of new schools
• The expansion of water and sewer lines
• The creation of parks and recreational facilities
• The building of new roads or additional lanes
• Public safety facilities, such as new fire stations or police substations

A limitation of impact fees is their restricted use. The revenue generated cannot be used for the ongoing operational or maintenance costs of public facilities, such as salaries or routine repairs. The funds are also prohibited from being used to correct existing infrastructure deficiencies present before the new development.

Calculating the Fee Amount

The calculation of an impact fee is not an arbitrary process; it must be grounded in a formal analysis. The fee amount must be directly linked to the costs incurred by the new development, a requirement governed by legal standards that ensure fairness and prevent the fee from becoming an unauthorized tax.

Two principles guide this calculation. The first is the “rational nexus” test, which requires a clear connection between the new development and the need for additional public infrastructure. For instance, a new residential subdivision creates a direct need for more school capacity and road infrastructure to handle increased traffic.

The second principle is “proportionality,” which dictates that the fee must be proportional to the development’s specific impact. A large commercial center that generates significant traffic will be assessed a higher road impact fee than a small retail store. This ensures that each developer pays only for their fair share of the necessary infrastructure expansion.

To establish these fee amounts, local governments typically hire specialized consulting firms to conduct an impact fee study. This study analyzes the community’s master plan, projects future growth, and identifies the infrastructure expansions required to serve that growth. The analysis calculates the cost of these new capital projects and then allocates those costs across the projected new development, often on a per-unit or per-square-foot basis.

The Imposition and Collection Process

The responsibility for paying the impact fee rests with the real estate developer. The local government assesses the fee on the new development, and the developer remits the payment to the municipality as a formal part of the development approval process.

The most common point of collection for impact fees is at the time the building permit is issued. Before construction can legally begin, the developer must pay the assessed fees for infrastructure such as roads, water, sewer, and schools.

While the developer is the party who writes the check to the city or county, the cost of the impact fee is not absorbed by their profit margin. Instead, this expense is treated as a cost of development. The fee amount is almost always incorporated into the final market price of the property, and the ultimate financial burden is passed on to the person who buys the new home or the business that leases the new commercial space.

Accounting and Use of Fee Revenue

Strict financial controls govern the management and use of impact fee revenue to ensure accountability. By law, these funds cannot be deposited into a local government’s general fund, which prevents the commingling of funds and ensures the fees are used for their intended purpose.

Impact fee revenues must be segregated into separate, earmarked accounts. These are often established as special revenue funds in the government’s accounting system, with specific accounts for each type of fee collected, such as a “Road Impact Fee Fund” or a “School Impact Fee Fund.”

The use of these funds is also geographically restricted. The capital projects built with impact fee revenue must benefit the general area from which the fees were collected.

A statutory time limit exists for the expenditure of these funds, often between five and ten years. During this period, the government must either spend or formally commit the funds to a specific project. If the municipality fails to use the collected fees within this period, it may be required to refund the money to the property owner of record.