Barring very special circumstances, taxes are a fact of life for the vast majority of people. Sales tax, income tax, and for home buyers and owners alike, property tax. By now, you’ve probably already paid property tax on your vehicle. But paying property tax on a home? That hits different.
Depending on the date of closing, the amount of property tax that a home buyer and seller are responsible for will vary. The process of figuring out who pays how much is called tax proration, and it’s one cost that many home buyers overlook when calculating their cash to close.
What Is “Tax Proration”?
Simply put: Tax proration helps level the playing field. Property taxes on homes are billed at the beginning of the calendar year for the year prior. So in 2023, you’d get a property tax bill for 2022. Let’s say you bought and closed on a home in November. Should you be responsible for the property taxes owed on that home for the months before closing? Didn’t think so. Proration involves a bit of math (don’t worry, nothing you need to worry about) to figure out how much of the bill each party is responsible for.
Tax proration /ˈtaks prō-ˈrā-shən/ n. When property taxes are fairly divided between buyer and seller based on date of ownership transfer or closing.
Here’s where it gets a little headache-y: Homeowners (or the sellers) don’t typically pay their part of the property tax bill directly. Depending on the date of closing, or the particular situation, there are a couple of options to consider:
In this situation, the sellers place their payment for the property tax bill in an escrow account. The buyers would do the same, and the bill would be paid from that escrow account when it’s due.
This process could be continued even after the buyers take the keys for the next annual property tax bill. Part of their monthly mortgage payment would go into the escrow account, accumulate over the year, and be used to pay the property tax bill on time.
Nope, not a line of credit. In this situation, the sellers issue a “credit” to the buyers at closing.
This doesn’t lower the home’s price directly, but it’s a similar mechanic. It’s essentially a discount on the closing costs, which would require the buyers to bring less cash to close — allowing them to use that “extra” cash to help pay the annual property tax bill.
Three Proration Pro-Tips
Before you walk into closing, keep these three tips in mind:
Depending on the market, the property tax bill could be used as leverage. In a seller’s market, where there are tons of competing bids, motivated buyers might offer to pay the seller’s portion of property taxes to get a leg up on the competition or expedite the sale. In a buyer’s market, the seller might offer to “pay” the entire property tax bill in exchange for coverage of other closing costs.
Age and disability status could come with tax implications, for yourself or the sellers. Those implications affect tax responsibility. For example, perhaps the seller is a disabled senior citizen. Local laws might have provided relief for that person — relief that is unlikely to be passed on to the buyer. Communicate with your team to determine potential roadblocks.
New builds, rehabilitation, and renovations will result in different tax assessments. New builds may not have received a tax assessment at the time of closing, and since there was no previous owner, the buyer would be responsible for an entire year’s worth of taxes. Rehab and renovation projects increase a home’s value, which could result in an increased tax bill. Make sure your assessment is up-to-date to avoid any surprises.
Coming Full Circle
After figuring out your initial prorated tax bill, new homeowners will be responsible for state and local property taxes for as long as they own the home. If that seems like a dim future, we’ve got some light: You may be able to deduct those property taxes (up to a certain amount) when it comes time to file your tax returns. Individually, you can deduct up to $5,000 in property taxes. Filing jointly? Double that figure and enjoy a $10,000 deduction.
But hey, we’re a mortgage company talking taxes here. Consult a tax professional to confirm your eligibility.
Now that you’ve got more detail on property tax proration, you’re prepared to close with confidence. But have you considered the elements of purchasing a home? Are you pre-approved? Do you know what goes into a down payment? We can help with those, too — it’s all part of our goal to give you the tools you need to feel better about borrowing.
Simply put: Tax proration helps level the playing field.