When it comes to selling a house, a homeowner will rarely walk away with the full amount they received for their home. Aside from real estate agent commissions, there are also several closing costs associated with the sale of a property such as title fees, mortgage pay-off costs, and transfer taxes which the seller will usually bear. According to Realtor.com, these third-party fees typically total 2% to 7% of the home’s purchase price.
Buyers may also incur costs associated with purchasing a home in the form of prorated taxes. If you are in the market to purchase a new property it is important to set aside enough money to meet these costs. In this article, we will help you understand more about prorated taxes when buying a home.
What Are Prorated Taxes?
Proration is the process of dividing property taxes between the buyer and the seller at the time of closing the real estate transaction. This way of splitting the tax burden ensures that each party is only paying according to their duration of ownership of the property.
In many states, property taxes are paid in arrears which means they are paid at the end of the tax year for the previous year. This means that the seller is still required to pay property tax up to the date they transferred ownership to the buyer, with the buyer taking on the responsibility for property tax thereafter.
To prorate the taxes according to ownership, at closing, the seller will give the buyer a credit for the period that they owned the property. This will generally be an estimate based on the amount of tax paid the previous year and may be readjusted once the current year’s tax bill is received.
The roles will be reversed where the seller has paid property taxes in advance. The burden will now shift to the buyer who will pay the seller a prorated amount based on the payment of taxes for the preceding year. It is important to address the issue of property taxes in the purchase agreement otherwise you risk having to pay property tax for a period when you did not own the property.
Calculating How Much Tax Should Be Paid
Property taxes are based on the fiscal year rather than the calendar year and this calendar will vary based on the state. Before you make your calculations it is important to check your state’s fiscal calendar and how they collect taxes. If you are the buyer in the transaction, below is an example of a simplified calculation to work out how much property tax should be paid to you by the seller.
- Ask the seller to provide you with a copy of their last property tax bill to find out the total amount of property tax that is payable on the property during the tax year.
- Calculate the number of days the seller owned the home during the tax year. This will be up to the day before the closing date and not the closing date itself. For example, if the property transaction closed on November 1st, the last day the seller is responsible for paying property tax will be October 31st.
- Divide the number of days the seller owned the property during the tax year by 365.
- This will give you the percentage of the tax year when the seller owned the property.
- Multiply this percentage by the total amount in the property tax bill to determine the amount of tax the seller is responsible for at the time of closing.
In cases where the seller has paid property taxes in advance, the buyer will need to credit the seller the appropriate amount at closing. This is calculated by arriving at step four above and subtracting this amount from the total property tax bill at step one. This will give you the prorated amount that the buyer is required to pay to the seller at closing.
Closing Statements
Once the calculations have been made, the prorated amounts of property tax will appear on the closing statement of each party as either a debit or a credit depending on which party owned the home at the time. Where the seller has paid property taxes in advance, the prorated amount will appear on the seller’s closing statement as a credit and as a debit for the buyer. In cases, where property taxes were paid by the seller in arrears, the opposite will apply.
Before you sign the purchase contract at closing, it is important to review the credit and debit amounts to check how the proration of taxes will be handled.