Tax season is around the corner. If you’ve become a homeowner in the past year, that means you could qualify for homeowner-related write-offs like mortgage interest and discount points. It also means you’ll need to pay property taxes. And to understand how to pay property taxes, you’ll need to understand tax proration.
Depending on the date of closing, the amount of property tax that a homebuyer 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 buyers overlook when calculating their cash to close.
What is tax proration?
Tax proration is when property taxes are fairly divided between buyer and seller based on the date of ownership transfer or closing.
Simply put: Tax proration helps level the playing field. Property taxes on homes are often billed at the beginning of the calendar year for the year prior. So in 2024, you’d get a property tax bill for 2023. Let’s say you bought and closed on a home in November 2023. Should you be responsible for the property taxes owed on that home for the months before closing? Didn’t think so. Enter tax proration.
Tax proration involves a bit of math to figure out how much of the bill each party is responsible for. Here’s where it gets more complicated: 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, you have a couple of payment options to consider.
How to pay property taxes with tax proration
| Escrow | Credit |
| 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. |
Tax proration pro-tips
Before you close on your home, keep these three tips in mind.
- Leverage: 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.
- Exemptions: 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.
- Projects: 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.
How to pay property taxes post-proration
After you’ve calculated and paid your initial prorated tax bill, you’re responsible for annual state and local property taxes for as long as you own the home. 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.
Keep in mind that property taxes vary depending on where you live and other factors, so there’s no single correct way to go about it. Consult a tax professional, do your research, and don’t take shortcuts as you take on this part of homeownership. Ok, now that we got the serious part out of the way: Deep breath. You’ve got this!
This material has been prepared for informational purposes only and is not intended to provide, and should not be relied on for, tax, legal, or accounting advice. You should consult your own tax, legal, and accounting advisors before making the decision to buy or refinance a home.
