TAX PRORATIONS IN A REAL ESTATE CLOSING: AN EXPLANATION BEHIND THE EQUATION.

TAX PRORATIONS IN A REAL ESTATE CLOSING: AN EXPLANATION BEHIND THE EQUATION.

If you are buying or selling a house, one of the more complicated issues you may encounter is the real estate tax proration.  Properties in Illinois are subject to taxes set by the county in which the real estate sits.  The paid taxes are distributed to the local government.

Real estate taxes are paid in “arears.”  This means that in the year 2021, you are paying the taxes for the year 2020.  Tax bills are payable twice a year in two installments.  If your property taxes are $2,000 per year, you receive a bill for $1,000 generally due in June, and a bill for $1,000 generally due in September.

If you are buying or selling a house, the taxes should be prorated based on the amount of time the seller lived in the house prior to the sale.  In other words, the buyer should not have to pay property taxes during the time that the seller occupied the property.

A tax proration is not necessarily a difficult calculation.  But it can seem tricky without an understanding of the underlying equation.

First, most real estate purchase contracts prorate taxes at a rate of 105%.  This is because taxes generally increase each year.  A higher percentage is better for the buyer because it causes the seller to pay a larger credit to the buyer for past taxes.  In some counties, such as Cook County, a proration of 110% is standard because taxes tend to increase in Cook at a faster rate than in other Illinois counties.

For example, if you are buying property in an Illinois county other than Cook, the real estate taxes on the property you plan to purchase may be $2,000 per year.  To calculate the taxes to be prorated, multiply the yearly taxes by 105%.  Then, divide that number by the number of days in the year.  The sellers should be responsible for the amount of unpaid real estate taxes for the number of days that they lived in the property prior to the sale date.

The equation is as follows:

$2,000 in real estate taxes per year;

x 105% = $2,100;

$2,100 / 365 = $5.75 per day in taxes.

 

Assume that the closing transaction occurs on March 31, 2021.  Remember that the property taxes due in 2021 are actually paying the taxes from the year 2020.  As a result, the seller should provide the buyer a credit for the entire 2020 taxes when the seller lived in the property.  The seller also needs to provide the buyer with a credit for the portion of the 2021 year that the seller continued to occupy the property.

For the year 2020 taxes, the seller would owe the buyer a credit of $2,100 ($2,000 x 105%).  In addition, the seller owes the buyer a credit for the time the seller lived in the property in 2021 – January, February, and March.

The daily property tax amount is multiplied by the number of days in January, February, and March: $5.75 x 90 = $517.50.  The total credit that the seller must provide to the buyer would be the $2,100 in unpaid taxes for the year 2020, plus the $517.50 for taxes in the year 2021 when the seller occupied the property, or $2,617.50.

As a result, when the buyer pays the year 2021 property taxes in 2022, the buyer is only paying for the portion of 2021 that the buyer lived in the property.

The following is another example.  Seller and buyer agree to a closing transaction on July 31, 2021.  Seller already received the bill for the 1st installment of the 2020 taxes and made a timely payment in June 2021.  This payment covered the taxes through June 2020.  But seller still lived in the property from July 2020 to December 2020, and until July 31, 2021.

As a result, and at a 105% presumed increase, the equation would look as follows:

$2,000 in real estate taxes per year;

$1,000 was already paid by the seller for the first installment of the year 2020;

$2,000 – $1,000 = $1,000 x 105% = $1,050;

$1,050 / 365 = $2.88 per day in taxes;

$2.88 per day * 214 days that the seller lived in the property for the year 2020 (sub-total $615.62);

plus $2.88 per day * 182 days that the seller lived in the property for the year 2021 (sub-total $1,046.50);

with a total of $1,662.60 owed as a credit to the buyer at the closing.

If you are buying or selling a home, local attorney Andrew Szocka provides thorough and speedy real-estate assistance in the Chicagoland area.  To schedule a free initial consultation, visit Andrew Szocka, P.C. online or call the office at (815) 455-8430.

 

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