How to Compute Real Estate Tax Proration and Tax Credits

Tax proration refers to the allocation or dividing of certain money items in the settlement sheet for real estate property transfer. An attorney, professional real estate salesperson, or mortgage broker Chicago performs the proration calculations at the closing and determines what amount of property taxes each party (seller and buyer) is supposed to pay. The seller of the property is supposed to pay taxes from New Year’s Day up to the date of the transfer. The buyer then assumes responsibility for the tax payments from the date of the transfer onwards.

Most items are easy to prorate and assign the calculated amounts to the buyer and seller in a real estate transaction. However, property taxes sometimes pose a change in the calculations because they tend to change from one fiscal year to the other without notice. The settlement statements can be lengthy and include itemization amounts, particularly those proration amounts affecting both the buyer and seller.

Before we look at an example of how a real estate tax proration calculator or calculation is done, here are just a few steps that help summarize the whole process for easier understanding;

  1. When computing tax proration, you start by determining the real estate taxes for the property during that year. The seller should produce a copy of the tax bill.
  2. They should then determine/calculate the number of days that the seller has owned the home during the property tax year, excluding the sale date.
  3. Divide the number of days you get from step 2 with 365 (total number of days in a year) in order to get the percentage of days during which the seller still owned the home during the property tax year.
  4. Take the percentage from step 3 and multiply it with the total property tax bill. The amount you get is what the seller should have paid in property taxes. If he has not yet paid this amount, the seller must reimburse you for the difference between what he is required to pay and what he has actually paid.
  5. Subtract the figure you get in step 4 from the total property tax bill and the difference is the prorated amount you are required to pay at closing as the buyer.

Note: As a buyer if you are itemizing deductions, you can claim tax credits for all the prorated tax amount on the property even if you were not required to reimburse the seller for the property tax already paid. Also, make sure to keep the closing statement safe because it may be required in the future as evidence that you paid your share of the property taxes.

Now let’s look at how to compute real estate tax proration in Chicago;

An in important point to note before beginning this computation is that the tax collections in the State of Illinois are set back one year. This is as a result of the one year property tax holiday granted by the State of Illinois during the Great Depression of the 1930’s.

Computation example;

Let’s assume that the tax bill provided by the seller for the first half of 2015 (Jan 1, 2015 to June 30, 2015) is $2,000. Because the bill is delivered almost a year after the period when the tax was incurred, the taxpayer does not know what his tax bill will be when property tax is actually being incurred. Therefore, he can only approximate his bill based on the previous tax bills.

So how does that apply?

When you buy some residential real estate property in Chicago, maybe with the help of a mortgage company, clear title is provided and all taxes that can be paid on it are paid up on the closing day. However, because we have mentioned that tax bills come out one year later after they are due, there will be an entire year of property tax liability that is unpaid and its actual bill unknown!

Here is how to go about the calculations;

If you make an offer to purchase a home in Chicago and the offer is accepted on June 1, 2016, considering that the closing date is September 30, 2016 and the full year tax bill for 2014 is $4000;

  • We will first calculate the estimated tax liability up to the closing date;

1st half of 2015 tax bill is $2200 (must be 55% of the full bill from the prior year i.e. 55% X 4000)

2nd Half of 2015 tax bill (unknown)
1st Half of 2016 tax bill (unknown)
Partial 2nd Half of 2016 tax bill (unknown)

The contract should call for a proration premium which is typically 105% or more. In this contract, the amount is 105%.

  • We then estimate the 2015 full year tax bill by simply multiplying the 2014 bill with 105%

$4000 X 1.05 = $4200

To find the amount for 2nd half of 2015:

We take $4200 (total estimated 2015 bill) and less the $2200 already paid for a credit of $2000 to be given at closing for this half.

  • To figure out our estimated 2016 full year bill, we simply multiply the 2014 bill with 105%.

$4000 X 1.05 = $4200.

For 2016, you will be paying half of the $4200 for the period 1/1/2016 to 6/30/2016 i.e. $2100

For the period 7/1/2016 to 9/30/2016 you would pay the fraction of;

((31+31+30)/365) x $4200 =$1058.64.

  • So, our closing statement will show the following credits;

2015 taxes 1st half: Paid
2015 2nd Half Credit: $2000.00
2016 1st Half Credit: $2100.00
2016 2nd Half Credit to 9/30/2016: $1058.64.

NB: In case you do not have a full year tax bill available and must create a base tax amount from scratch, consult your mortgage broker Chicago for advice. Normally, new homes that have no tax records yet in Chicago use 2% of the purchase price for computation because it is the approximate annual maximum tax rate in the city.

There may be many Chicago mortgage companies at your choice, but none of them delivers like A and N mortgage! We offer you all the relevant advice relating to your home purchase for a smooth transaction process. Call us today for consultation at 312-793-3000 and ask any questions you may have about tax proration and tax credits.

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