Tax Proration for New Construction and Divided Parcels

Make sure all parties pay their fair share


 Tom Cullen  |    June 08, 2005
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In the typical real estate transaction, the real estate taxes for the year of the closing are prorated, that is, divided between the seller and buyer in the manner stated in the offer to purchase. The seller is responsible for the property taxes from January 1 to the day prior to closing, and the buyer is responsible from the day of closing through the end of the year. At closing the buyer receives the seller’s portion of the taxes through a credit on the closing statement. The buyer is then responsible to pay the entire tax bill when it becomes due at the end of the year.

Unless the offer language is modified, the preprinted language in the offers to purchase — see lines 48-52 of the WB-11 Residential Offer to Purchase — states that the proration shall be based on the net general real estate taxes for the current year, if known — otherwise on the net general taxes for the preceding year. The seller and the buyer, who may state a different tax proration formula on the contract, determine the basis of the tax proration.

In most residential transactions the real estate tax proration is not a problem. The seller’s credit is usually based on the previous year’s tax bill except for closings in December when the tax bill is available, and in most circumstances this represents an equitable division of the current year’s tax bill between the buyer and seller.

New construction tax proration

Unfortunately, the equitable division is sometimes not so equitable in new construction transactions. Local assessors are required by law to value property as of January 1 of each year. Prior to construction, the tax bill from the previous year only represents the value of the vacant land. The tax bill in the year of closing is based upon the value of the property as of January 1, when the property may have still been vacant land, or it may have included the new building or a partially completed structure. Unless the closing is in December, the parties will not have a tax bill that is based upon the completed structure and the tax proration will be distorted and inequitable if it is based on the prior year’s vacant land tax bill.

For example, assume a builder begins construction of a new home on a vacant lot on September 1, 2004. Because the 2004 property taxes are based on the assessed value of the property as of January 1, 2004, the 2004 tax bill reflects the assessed value of the vacant lot (a $500 tax bill). By January 1, 2005 the construction project is 66 percent complete. The local assessor values the property as of January 1, 2005, resulting in a 2005 tax bill that reflects the value of the house as a partially completed structure (a $4,000 tax bill).

A buyer purchases the completed home on May 15, 2005. Since the 2005 tax bill is not available at the time of closing, the standard language of the offer requires the tax proration to be based on the 2004 bill, which was $500. As a result, the seller’s property tax credit will be around $200. At the end of the year, however, the buyer will get the 2005 tax bill for $4,000. The net result is that the buyer pays $3,800 and the seller pays only $200. If the buyer was not properly informed about this potential outcome, the real estate agent will have the unenviable job of explaining that the taxes were properly prorated according to the offer.

Educate and disclose

As the example demonstrates, agents need to educate sellers and buyers and explain how and why real estate taxes increase with new construction and reassessments. Buyers need this information so that they may properly budget for the future; sellers need this information so that they can negotiate a reasonable tax proration in the offer to purchase. Once the parties understand there is going to be a dramatic tax increase, they may want to negotiate the establishment of an escrow account for the payment of property taxes at the end of the year, establish a formula using an estimated assessed value based upon comparable properties and the last known mill rate, or agree that the taxes will be prorated at the end of the year when the actual tax bill is known.

Sellers should also be mindful that the offer to purchase requires disclosure of any completed or pending reassessment of the property for property tax purposes. State statute requires the local assessor to notify property owners of any change in their assessment. Receipt of a reassessment notice triggers a disclosure duty for the seller, and for the listing agent if the seller fails to disclose the reassessment.

Parcel splits and tax proration

A somewhat thorny issue is the allocation of real estate taxes when a parcel is sub-divided. The local assessor values property as of January 1, so in the year that a parcel is divided there will only be one tax bill for two or more lots. If the lots are sold, multiple property owners will be responsible for a portion of one tax bill. This can be problematic if the property owners cannot agree on an equitable division or if one of the property owners fails to pay their taxes. The worse case scenario would be for the county to foreclose on the entire parcel because the owner of one of the new lots did not pay his or her share of the property taxes.

Fortunately, Wis. Stat. § 70.323 (1)(b) provides a procedure whereby the owners of new parcels resulting from a recent land division can make a written request to the treasurer of the taxation district asking for a separate valuation of each new lot or parcel. According to the statute “the value of each new parcel shall represent a reasonable apportionment of the valuation of the original undivided parcel, and the total of the new valuations shall equal the valuation of the original undivided parcel on January 1 of that year.”

Although there is still one tax bill, the benefit of separate assessments is a lien extinguishment right. If a property owner of a new lot or parcel does not pay his or her taxes, the tax foreclosure rights of the government only extend to that owner’s parcel and will not affect the owners of the other new parcels who have paid their separate portions of the property tax bill for the original parcel.

However, it is important to note that this procedure does not apply if the property owners have a written agreement providing for the payment of taxes in the year of division. In other words, when a new parcel is sold, the offer should state that the parties agree to split the assessment and to pay the taxes based upon the assessor’s valuation decision. Any other agreement in the offer, such as the standard language in the offer to purchase, will prohibit the assessor from dividing the assessment.

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