To Re-prorate Or Not To Re-prorate (Real Property Taxes); That Is The Question

The answer: it depends on whether you are the buyer or the seller, and whether the purchase price is higher or lower than the taxable value of the property at transfer.

Background: By way of background, proration and re-proration are concepts necessary in the transfer of real estate in Ohio, because real estate taxes are paid “in arrears.” In other words, the bills that were sent out in June, 2008 were actually for July through December of 2007 taxes, and the bills that come out in December, 2008, will be for January through June of 2008 taxes. Because Ohio real estate taxes may be paid in two, six-month installments, they are said to be “six months in arrears”. Paying real estate taxes in arrears is a concept that many states initiated during the Depression, when many could not afford to pay their property taxes when actually incurred.

Proration 101: Because of the payment in arrears phenomenon, the taxpayer is, in effect, paying taxes based on a non-current valuation of their property. Nonetheless, most real estate contracts contain a clause to the effect that “real estate taxes and assessments shall be prorated based on the latest available tax duplicate”. This proration language translates to mean that the amount owed by the seller for taxes between the last tax bill paid and the transfer date will be credited to buyer at closing, so when the next bill comes to the buyer after closing, the buyer will have been paid for the period of time that seller owned the property. The above-described method is sometimes called the “short proration” method. Some counties in Ohio, unless specified in the contract otherwise, traditionally use the “long proration method.” In that method, the entire first tax bill that will be due after the closing date is paid by the seller at closing, and then the second six-month bill due after the closing date is prorated, just as in the short proration method.

The problem with prorating taxes that are paid in arrears is that the valuation that comes out in subsequent tax bills, may be more or less than the “latest available” tax duplicate at the time of closing. When the tax bill is sent to the buyer after closing, if the valuation (and resulting taxes) is higher than the valuation used as a base at closing to prorate the taxes, the buyer will be paying for the increase in taxes, for the time the seller owned the property. While this is unfair to the buyer, the buyer can do nothing about it unless there is a “re-proration clause” in the buyer’s contract, allowing the buyer to go back to the seller for its prorata share of such increase in the taxes.

Should buyers, then, always insist on a re-proration clause? The answer is no, because if the tax bill after closing has a lower valuation than the one available at closing, the buyer would have to pay back to the seller, the buyer’s windfall resulting from a higher than actual valuation for the time period seller owned the property.

So, when should you provide for a re-proration clause, when you don’t have a crystal ball as to whether the property will increase or decrease in valuation? One easy rule of thumb is to look at the valuation called for in the latest available tax bill, and compare same to the purchase price. If the purchase price is higher than the current valuation, and you are (or represent) the buyer, you want a re-proration clause. If the purchase price is lower than the valuation displayed on the tax bill at the closing, and you are (or represent)the buyer, you won’t want a re-proration clause. Sellers in the above examples will want the opposite.

The "crystal ball" for the above referenced rule of thumb is the Ohio Supreme Court’s ruling in Berea Bd. of Edn. v Cuyahoga Cty Bd. of Revision, 23 Ohio St. 3d 59 (2005). In the Berea case, the Court ruled that "when [a] property has been the subject of a recent arm's length sale between a willing seller and a willing buyer, the sale price of the property shall be the 'true value for tax purposes'. As a result of that ruling, counties traditionally will increase the valuation after a sale higher than the previous valuation. While counties may not decrease their valuation if a purchase price is lower than the previous valuation, the taxpayer may petition the County for a tax refund, and should ultimately prevail if the "Berea test" is met. Since sellers will no longer own the property after closing, however, sellers (or those representing sellers) will want to insist upon a clause in their purchase agreement that not only allows for a re-proration (when the purchase price is lower than the valuation at closing), but creates an obligation of the buyer to file (and a right of the seller to join with the buyer in) an action to reduce taxes.

The bottom line on re-proration is that buyers should consider a re-proration clause when the purchase price exceeds the County’s valuation at closing, and sellers should consider negotiating for a re-proration clause when the purchase price is lower than the valuation at the Board of Revision.

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