Susan Galyean
Susan Galyean Real Estate

Property Taxes and Your Closing

The subject of property taxes prorations may cause more anxiety for both buyers and sellers than any other aspect of their real estate closing. Before signing a contract to purchase or sell real estate, you should fully understand how Texas property tax laws will affect your bottom line, both at the closing table and into the future. Before thinking specifically about your transaction, familiarize yourself with some basic concepts. Be sure you understand how property values are established, how qualified exemptions can change a property’s valuation, and when tax assessments are paid.

Tax prorations are easier to understand if we look at an example, so let’s pretend that we are about to close on the sale or purchase of a property and see what happens. Here are some pertinent facts to consider:

·         This transaction involves an existing home, not new construction.

·         Our closing is set for June 30th.

·         Last year’s actual taxes were $6,000.

·         Last year’s tax rate was 3.0 %.

·         Last year’s valuation was $200,000.

·         This year’s valuation is $220,000.

·         Our sales price is $250,000.

·       Because sales prices in the area have gone up in the last 12 months, the seller did not protest the new valuation.

·        Last year’s taxes were paid on time.

·       The only exemption that has been filed on the property is a homestead exemption which has been in place for the last 5 years.

How does the closing agent (usually a title company representative) figure out how much the buyer and seller each owe for property taxes at closing?

First of all, since the seller didn’t file a protest of the property’s valuation, and it is too late for the new owner to do so, we know that the valuation will be set at $220,000 for the current calendar year. Secondly, since Texas property taxes are paid in arrears (at the end of the year), and the tax rates are not set until the third quarter, the only information we have about tax rates is last year’s tax rate of 3%. So we are starting off with an “estimated” total property tax of $6600 (3% of $220,000) for the calendar year.

In our example, we are closing on June 30th, which is the 181st day of the year (unless it is a leap year). The seller is responsible for the property taxes from January 1st through the day of closing, so the seller will be charged at closing with taxes for 181 days. If we divide the estimated tax bill of $6600 by 365 days, we get a daily tax estimate of $18.082191781. Multiply it out and you will see that the seller’s portion at closing will be $3272.88 and the buyer will be responsible for the remainder of $3327.12 as long as the tax rate is the same as last year’s rate.

Warning for Sellers: 

If the seller has an escrow account with a mortgage company, he may assume that his portion of the property taxes will come out of his escrow account, but this is NOT the case. Sellers must pay their share of property taxes at closing, even if it means bringing money to closing! Once they receive the loan payoff, the mortgage company will refund the money in the escrow account, usually within 30 days after the closing.

Buyers need to know that they will be credited with the sellers’ portion of taxes at closing, but they will then have to pay the property taxes for the entire year when the tax bills are due at year’s end. If the tax rate goes up and the actual taxes are higher than the estimated taxes used for closing prorations, the buyer may notify the seller at the end of the year and receive reimbursement for the amount they are short unless this type of adjustment is prohibited by the purchase contract.

Buyers Beware:

When purchasing a foreclosure, your purchase contract will typically say that the buyer assumes the risk for tax rate increases and that no adjustments for taxes will be made after the transaction closes.

If the buyer is obtaining a mortgage loan to purchase the property, the lender may require that the buyer set up an escrow account for property taxes and insurance. This is also done at closing. Most lenders want an initial deposit into escrow of the “estimated” property taxes that have accrued prior to the closing (sellers’ portion) plus an additional 4 months. Check with your lender to find out what they require when setting up an escrow account. With a 20% down payment or more, some lenders will allow purchasers to “self-escrow”, but they typically charge an upfront fee at closing to waive the escrow account requirement.

More Things for the Buyer to Think About

Changes in Exemptions

In our example, the sales price is $250,000 and the tax valuation for the current year is $220,000. The sellers have a homestead exemption in place which kept the valuation from going up more than 10% in a single year, but the buyer will need to file their own homestead exemption in January of the year following the purchase. Even though the new exemption is filed, the appraisal district has the right to raise the property valuation to the new sales price because the property has changed owners. So, in the year following the purchase, the buyers should anticipate an increase in their property taxes of approximately $900, and that is only if the tax rate stays about the same at 3%. Once the new owner has filed their homestead exemption and owner occupied the property for two consecutive years, they will enjoy the annual 10% cap in valuation increases like the previous owner occupant did.

If the taxes on a property you are about to purchase look much lower than surrounding properties, be very careful. Make sure your Realtor® checks on existing exemptions (over-65, disabled person, disabled veteran, etc.) that may vanish once the property changes ownership.

New Construction

The most important factor in determining actual taxes for a newly constructed home is the status of the construction on January 1 of the year in which it is purchased. If the lot is vacant, the annual taxes will be based on the value of the lot. If construction has been started, the appraisal district must estimate the percentage of construction that has been finished on January 1 and add that to the lot value. When closing on a newly constructed home, remember that the appraisal district will raise the valuation of the home to lot value plus 100% of the value of the improvements on the following January 1st. So don’t get too attached to those artificially low taxes right after you buy that new home. It won’t last!

End of the Year Closings & Tax Limbo!

Sellers must be especially alert when closing near the end of the calendar year. If the property tax bill for the year is available, the title company or attorney handling the closing will pay the taxes in full at the closing unless they can verify receipt of payment from the appraisal district. If the sellers’ mortgage company is paying the taxes from an escrow account, the taxes may have been paid but not yet credited to the sellers’ account by the appraisal district. This happens frequently because mortgage servicing companies typically send payments for hundreds of homeowners in a lump sum.

The seller may be caught in a situation where his taxes have been paid from escrow, but because they have not yet been credited to his account at the appraisal district, the closing officer must collect them a second time at closing. When this happens, some closing officers will agree to “hold” the payment for a few days, hoping to verify payment with the appraisal district and return the funds directly to the seller. But in a worst case scenario, the appraisal district receives both payments and must then return one to the seller.