A primer on property taxes

Percentage paid at closing varies by state

By Inman News Feed
Add Comment Add Comment | Comments: 0 | Posted Aug. 18, 2009

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Percentage paid at closing varies by state

Bernice Ross
Inman News

DEAR BERNICE: Do I have to pay 2008 or 2009 taxes in escrow? What things should I be considering before going ahead? Please point me in the right direction. I really appreciate your help. --Frank P.

DEAR FRANK: I assume that you're asking about property taxes, but city, state and federal taxes can also be issues that you must address before you close your transaction.

The amount you will have to pay in property taxes is contingent upon the time of year that you close. If you are putting less than 20 percent down, your lender may require you to pay one-twelfth of your property taxes each month as part of your mortgage payment.

These monies are deposited on your behalf into an impound account. At tax time, the lender pays your property taxes. As part of your closing costs, the lender will collect several months of taxes to set up the impound account.

The rates and ways in which taxes are assessed vary tremendously. Various taxing entities such as cities or school districts have the right to levy taxes against your property. This may be a flat percentage of the sales price with an adjustment each year (the system used in California under Proposition 13) or it could be based upon a percentage that each taxing entity levies in combination of the appraised value.

In Texas, for example, the county appraisal district appraises the value of each home. The school district, the city and several other entities then assess a specified percentage of that amount as the tax.

When and how taxes are collected also varies. To illustrate, if you were to buy a home in California, the seller's tax rate might be significantly lower than the rate that you would pay once you close on the property. If the sellers had been in the home for 20 years and paid $100,000 for the property, their tax rate would be $1,200 per year plus a maximum 2 percent increase each year.

If you paid $500,000 for the property, then your tax rate would be $6,000 per year. The escrow agent would prorate the percentage of taxes that would be owed under the old rate. After you close, the county where the property is located will reassess your property based upon the new sales price. They would then issue a new tax bill.

Depending on whether your property has decreased or increased in value, you could receive a refund or a much higher bill. Again, this depends upon the difference in the seller's current appraised value and your current purchase price.

Many buyers see that the property taxes are prorated at closing and believe that they have handled their property tax obligation. If you are assessed at a higher amount than the previous owner, your "supplemental tax bill" may arrive as an unwelcome surprise.

In contrast, Texas sets your property value at the beginning of the year. For example, when we were building our house, only the foundation was complete on Jan. 1, the date upon which they base your property value. We closed in July. I was pleasantly surprised that our property taxes were not prorated based upon the new value once the house was completed. Instead, they were based on the Jan. 1 value. They then increased to the appraised value the next year. In California, the change goes into effect the day that you close.

The amount of taxes paid in different states can also be quite different. Property taxes on a $500,000 house in California would be $6,000 per year. Property taxes on a $500,000 house in Austin, Texas, would be about $12,000. To understand what will happen in your situation, speak with a competent local Realtor.

Property taxes are not the only issue you may need to address. In order to provide you with a clear title, the title company will check for other types of tax liens. When a homeowner doesn't pay their taxes, the taxing entity can place a lien on the property. I've seen liens for federal, state and local taxes.

The transaction cannot close unless the entity that placed the lien on the property releases the lien. While city and state tax liens can be resolved, my experience has been IRS liens are almost impossible to remove in a timely fashion. It can take months or even years to resolve.

As a buyer, the title company will also check to see whether you have any liens or judgments filed against you. If you haven't cleaned these up, you may not be able to close the transaction until they are paid.

On the positive side, because mortgage interest is normally deductible, you may be able to increase how much you take home from your paycheck. If you are an employee who receives W-2 income, you can ask your employer to change your deductions so that you take home more money. This is due to the fact that mortgage interest is normally deductible. (If you're making a lot of money, you may fall under "alternative minimum tax" requirements that can limit this deduction.)

Consequently, before you enter into a contract to purchase, consult your CPA or tax attorney for advice on how your purchase will influence your tax situation.

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