What You Need to Know About Prorated Taxes in a Real Estate Transaction

Your Guide to Prorated Taxes in a Real Estate Transaction

by on June 15th, 2020 in Real Estate Law

In both commercial and residential real estate transactions in Florida, the real estate taxes are prorated as of the date of the closing. This is generally a matter covered in the purchase and sale agreement and sometimes is memorialized in a separate agreement referred to as a tax proration agreement.

What Does Prorated Taxes Mean and Why Is It Necessary?

In Florida, real estate taxes are paid in arrears. That means that you pay your real estate taxes at the end of the year for the prior year. In a real estate transaction that closes prior to the time when real estate taxes are paid for the year, the Seller gives the Buyer a credit for taxes for the period of time when Seller owned the property. The tax proration is generally an estimate based upon the prior year’s taxes for that particular property. For example, assume real estate taxes for Property A were $1,000 in 2019. Buyer and Seller are closing on the sale and purchase of Property A on May 1, 2020. At the closing, Seller will give a credit to Buyer for the period of time that Seller owned Property A (4 months). Therefore, the credit due from Seller to Buyer at the closing of Property A will equal ($1,000/12) * 4 = $333.33. Buyer will then be responsible for paying the entire real estate tax bill when it comes due at the end of 2020, in this example this amount would be $1,000. In Florida, it is important to note that tax amounts are released in November of the year prior to the time that they are officially due. If you pay your taxes by November 30 of each year you will receive a discount on your taxes for the year (there is also a lesser discount if you pay your taxes in December).

Do Real Estate Taxes Change After a Sale?

The answer to this question is what has caused a lot of confusion and problems that arise after a real estate transaction has closed. The short answer to this question is: probably yes. After a sale, the property appraiser has the ability to re-assess the property at its current market value. Typically the Pinellas County Property Appraiser will assess the property at approximately 80% to 90% of the sale price but they are not bound to that range. The property appraiser has the ability to assess the property at market value and apply the millage rate to calculate the taxes due.

Homestead/Save Our Homes (SOH)

In the State of Florida, homestead rights and the save our homes cap accompany a person’s homestead property. The property appraiser is only permitted to raise the assessed value of your homestead property by a maximum of three percent (3%) per year of the change in Consumer Price Index, whichever is lower. The cap and exemption are removed at the end of the year if the property has been sold. The result of this is that parties who have owned their homes for long periods of time have very low taxes because of the save our homes cap. When they sell their homes, the cap is removed and the property is reassessed; this results in the property being assessed at the much higher value which, in turn, equates to much higher taxes.

How Are Taxes Calculated in Florida?

Property taxes in the State of Florida are calculated by applying the “Millage Rate” to the assessed value of the property. A millage rate is the tax rate used to calculate taxes on real property. The millage rate represents the amount of tax per every $1,000 of a property’s assessed value. Assigned millage rates are multiplied by the total taxable value of the property in order to arrive at the property taxes. For example, in St. Petersburg, Florida the millage rate for 2019 is: 21.5570. Assume Property B has an assessed value of $200,000. The real estate taxes for Property B are equal to ($200,000/1000) x 21.5570 = $4,311.40.

The Reassessment Dilemma

The issue that is caused by the Save Our Homes Cap and the maximum annual increase is that Sellers of real estate who have owned their property for a long period of time have a taxable assessed value that is drastically below the market value of the property. Upon the sale, which is presumably at or around market value, the property appraiser re-assesses the property at 80% – 90% of the sales price. This results in the prorated tax credit given at closing that is drastically lower than the entire tax bill that the Buyer is required to pay at the end of the year. The joint committee of the Florida Bar and the Florida Association of Realtors (“FAR-BAR”) has devised the concept of “tax reproration” as a solution to this dilemma. The “tax re-proration” clause is memorialized in FAR-BAR’s AS IS Residential Contract for Sale and Purchase in Paragraph 18 (K) and states: “A tax proration based upon an estimate shall, at either party’s request, be readjusted upon receipt of the current year’s tax bill. This STANDARD K shall survive Closing.” This provision allows either party to a real estate transaction to request a re-proration of the year’s taxes.

Re-Proration Example

Seller has owned a property located in the Old Northeast neighborhood of St. Petersburg, Florida for 50 years. Property C. Seller paid $50,000 for Property C at the time Seller acquired the property. Property C has been Seller’s homestead for the entire time that Seller owned Property C. In 2020, Seller sold Property C to Buyer for $800,000.00, the closing occurred on May 1, 2020.

At closing, Seller provided Buyer with a credit based upon taxes from the prior year (2019). The taxes for 2019 are equal to: Property C’s assessed value (with SOH cap): ($65,000.00/1000) * 21.5570 (2019 millage rate) = $1,401.21. Therefore, Seller provided Buyer with a credit to compensate Buyer for Seller’s period of ownership (4 months). The credit Buyer received at closing was equal to: ($1,401.21/12) * 4 = $467.07.

Following the sale, Property C was re-assessed at 90% of its Market Value, which is the sales price of Property C. The assessed value is equal to $800,000 x .9 = $720,000. Therefore, when the tax bill comes due in November it will be equal to: ($720,000/1000) x 21.5570 = $15,521.04. Buyer will be expected to pay this entire tax bill.

Under the contract Buyer requests a re-proration. The difference between what the credit at closing actually was at closing and what it would have been given the actual taxes will be due to the buyer. The credit at closing “should have been” equal to ($15,521.04/12) * 4 = $5,173.68. The amount that is due to buyer due to the re-proration is equal to: $5,173.68 – $467.07 = $4,706.61.

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