Thank you for allowing me to speak with you today about the role of attorneys in Illinois real estate transactions. I am an Illinois-licensed attorney with 12 years of experience in real estate and other areas of the law. For this presentation, I am going to first take a few minutes to give you a bird’s eye view of the real estate attorney’s part in the closing process, as it relates to representing buyers and sellers. Then, I am going to zero in on one important issue that can often present problems in Illinois Real Estate transactions and should be on the radar of all real estate attorneys and realtors involved in residential real estate practice in Illinois; ie, the calculation of tax proration credits. I will go over the basics of real estate tax proration calculation, scenarios that can lead to conflicts and unpleasant surprises, and strategies to resolve common problems.
By way of basic background, lets review the basic responsibilities of real estate attorneys in Illinois residential transactions.
When representing buyers attorneys are typically responsible for:
- reviewing the contract and real estate disclosures,
- Requesting contract modifications as needed under attorney review provision
- negotiating inspection issues as needed under professional inspection contingency, as needed
- drafting addendums for parties agreed-to changes
- Requesting extensions as needed and helping buyer obtain required documents for their lender
- Attending closing and review of closing documents.
When representing Sellers, the attorneys role includes:
- Reviewing the contract and real estate disclosures,
- Requesting contract modifications as needed under attorney review provision
- Preparation of conveyance and closing docs and statement
- Ordering and writing the title insurance policy from a title insurance policy of their choice
- Obtaining necessary payoffs, releases, certificates and other clearance documents to release or insure over unpermitted exceptions on the title insurance policy
- In case the property is a condominium, obtaining required HOA documents for buyer’s and lender’s review and approval
- Attending closing and review of all of seller documents
Each of those areas could warrant its own in-depth presentation and case studies. However, as I will not be able to go into significant detail regarding all of the above tasks, I thought it would be more helpful and informative to zero in on one important issue that comes up for buyer’s and seller’s attorneys, usually under attorney review. The issue I will be presenting in today is the negotiation and calculation of real estate tax prorations. While the topic may seem dry at first glance, all real estate attorneys and realtors must have a basic understanding of real estate tax prorations, and should keep tabs on this issue in each transaction, so as to avoid potential pitfalls and unhappy clients.
So as a primer, taxes are calculated by multiplying three together three factors:
- assessed value of land and improvements
- equalization factor
- tax rate
The resulting tax amount is sometimes reduced by what are called “exemptions”: These are in effect discounts offered to qualifying taxpayers to reduce the amount of real estate tax they would otherwise owe. The most common of which are homeowner’s exemption, senior exemption and senior freeze exemption. If you are curious, you can find the assessed value, equalization factor, tax rate, and any exemption applied on any real estate tax bill.
In Illinois, real estate taxes are paid in two installments, a year behind. So for instance, the first installment of the 2019 tax bill won’t be payable until March of 2020, and the second installment of 2019 won’t be payable until August of 2020. Based on this delay, when someone buys real estate in Illinois, they are sure to inherit a future tax bill from a period of time from before they acquired the property. To solve this problem, the standard contracts provide that Seller gives real estate tax proration credit to buyer, so that buyer is credited the taxes he will eventually have to pay for the time period preceding closing. Usually, the base of the credit is the last ascertainable tax bill, often multiplied by 105% or 110% to account for possible increase in tax bills for the following year. The credit is normally calculated by simply dividing the base into 365 days, multiplying out the per diem through date of closing, and accounting for first installment payments if the same have been made. However, there are a number of scenarios to keep in mind where using the last ascertainable tax year, even when multiplied by 105 or 110%, would be improper and insufficient to cover buyer’s future taxes.
The first problematic scenario is when the assessor’s office re-assesses the subject property for the future tax year at a value significantly higher than the previous year. That is why every real estate attorney and every realtor that wants to stay ahead of the game should check the county assessor’s website to determine whether the valuation for the new current tax year is already up. If so, you will notice that sometimes it can be significantly greater (and sometimes smaller) than the prior year. If the valuation has gone up, attorneys representing buyers will usually ask that tax prorations be calculated using the new assessment and latest tax rate and equalization factor, rather than just the prior tax year.
Senior Freeze/ Senior Exemptions
Another issue that often comes up is when the last ascertainable tax bill has exemptions that the buyer does not qualify for and is likely to lose. The senior exemption provides an extra reduction to the taxpayer, and the senior freeze freezes the equalized assessed value from year prior to the applicant’s request for the same. However, as the name suggests, the homeowner receiving said exemptions has to be a senior, and has to apply for and meet the income requirements for senior freeze each year. A non senior will not qualify, and will lose the senior exemption and senior freeze that the qualifying seller had on the taxes. If that happens, the result will be woefully inadequate tax prorations given to the buyer, that will not cover buyer’s actual pre-closing portion of the tax bill. Buyer’s attorneys will typically ask that the exemptions are added in calculating the prorations. Seller’s attorneys often counter that the applications have been submitted and are likely to carry over for the tax year in question, and that adding the exemptions back into the prorations. The fair solution in these scenarios where there is uncertainty about the future of exemptions on the next tax bill is usually to have a post-closing reproration agreement, and an escrow held by the title insurance company or one of the attorneys sufficient to cover the difference between the tax prorations being given to the buyer, and the worst case scenario where the tax bill loses the prior year’s exemptions.
Newly constructed homes provide another example where the typical tax proration practice of using the last ascertainable tax year as a basis is insufficient. The reason for this is that very often, the last ascertainable tax bills for new constructions have them assessed for only the land value, and not the improvement. If the improvements are assessed for the next tax year, this will result in an enormous jump in the tax bill, usually by orders several orders of magnitude. In these scenarios, a post closing escrow hold back and re-proration agreement is essential to protect the buyer from bearing most of the burden of the pre-closing tax obligations. The hold back is usually between 1.5% and 3% of the purchase price. Of course this can be negotiated based on comps in the area, etc. Another issue that is sometimes discussed / negotiated in the context of re-proration for new construction, is whether the reproration will be a strait reproration using the final tax bill, or whether the seller’s portion of the reproration would include land and that portion of the improvement assessment that happened prior to the closing. The concept behind this being that if the property was assessed with the improvement only after the buyer’s purchased it, the buyer should be responsible for that extra assessment as it was assessed during their ownership, and not the seller’s. The extent to which this argument resonates will really depend on whether you are representing the seller or buyer. In any case, in my experience, the more typical practice is a strait proration of the taxes, irrespective of when improvements where assessed.
And with that, I want to thank you for letting me speak to you today. I hope I was able to give you a glimpse of the role real estate attorneys play in residential closings in Illinois, as well as a more in-depth outline of the important topic of real estate tax prorations, which all real estate attorneys and agents should be familiar with. If you have any questions regarding this or any other real estate related topic, I am happy to stick around to take questions,. Please also feel free to reach out to me by phone or email.
I hope that you will consider recommending my services to your clients, and that we can work together on closing some deals in the new year.