Real estate taxes for Illinois purchase and sale transactions can be confusing. When buyers and sellers meet at the closing table, they have to deal with one large conundrum. Because property taxes are paid in arrears (meaning that we pay this year for owning the property last year), the buyer and seller have to figure out how to deal with the real estate taxes for the period during which the seller has owned the real estate but for which taxes have not yet been paid! This can be difficult, to say the least and there are many ways to deal with the issue.
A short and incomplete bit of history on the property tax
Property taxes are nothing new in Illinois. When the State passed its first constitution way back in 1818, it provided that “…the mode of levying a tax shall be by valuation so that every person shall pay a property tax in proportion to the value of the property he or she has in his or her possession.” So, going all the way back to its early beginnings, Illinois has taxed the value of personal property and real estate.
Long ago when I became and attorney and started to perform real estate closings, I heard the anecdote at the closing table that real estate taxes were paid in arrears because of the Great Depression. I took that at face value and it appears to be true. It seems that things were fairly peachy with that until the 1930s. Debts were mounting and all of a sudden, the State and the local townships were running around collecting taxes.
After a small amount of incomplete research on this topic, I learned that people were, not surprisingly, pretty unhappy about being taxed during the depression era. So much so that they just decided to stop paying taxes. In an April 15, 2011 article in the Wall Street Journal, David Beito discussed the “Forgotten Tax Revolt of the 1930s“. In that article, he cites a New York Times journalist at the time writing “the nearest thing to a political revolution in the country is the tax revolt. . . . Taxpayers are wrought up to the point of willingness to give up public services. ‘We’ll do without county agents,’ they say. ‘We’ll give up the public health service.'” Hmmm… that doesn’t sound too familiar!
So, it seems that in 1933 and thereafter, the State decided to leave real estate taxation to the local authorities. In place of the state real estate tax, Illinois adopted a sales tax that exists to this day. Since 1933, the state has not collected ad valorem real estate taxes. A December 29, 1934 article in The Daily Illini newspaper indicates that the state tax board decided to “continue its action of a year ago when it waived the state tax payable in 1934.” The article also indicates that in 1933, the state collected 50 cents for every $100 of valuation in real estate taxes.
The solution and the aftermath of the depression
As documented by Ilyce R. Glink in her book 100 Questions Every First-Time Home Buyer Should Ask documents that in 1930, because so many people were having trouble paying their taxes, Cook County gave people a year off. They delayed the payment (but not the obligation to eventually pay). That put us behind by one year. Interestingly, until 1933, when the state waived the obligation, the only source of funds to fund State government was the property tax levy. In the years since the first waiver, the State of Illinois has not collected any real estate taxes. It may seem crazy now, but even in the 1940’s, the state taxing authority was meeting and continued to extend the waiver of real property taxes for Illinois property. Does anyone know of a state that really needs money and might be looking for a way to collect? Hmmmm.
Uncertainty of taxes for Chicago real estate
So, in a traditional real estate closing, we have a problem. The unknown. The unknown tax bill to be exact. Sitting here today (tax day, April 15, 2016), neither I, the Cook County Treasurer, the Cook County Assessor, the Mayor of Chicago, nor anyone else can tell you what the property tax bill will be when it comes out in July, 2016 (assuming it comes out on time). Budget’s aren’t yet known, the tax assessment appeals are not complete yet, the property tax exemption forms aren’t all submitted, the state equalization factor hasn’t been determined. So, 2015 taxes, payable in 2016 are an unknown (and 2016 payable in 2017 is even more unknown). Add to this the fact that we have not seen the impact of the 2015 triennial reassessment of the properties in Chicago, the Mayor’s record breaking budget calling for extra taxes, and we have no idea what the City will propose or the State will pass with regard to possible tax relief for certain Chicago properties and what we have is a big bag of “Nobody knows”.
So how does this affect closings?
Real estate contracts are the place where we get down to the nitty-gritty of the real estate tax problem for closings. Most of the common real estate forms call for a proration of the real estate taxes based on the best information available to the parties. Remember, the problem is that we don’t know what the taxes for 2015 will be until July. By the way, that tax bill that came out in February of 2016 doesn’t tell us anything. That bill sent by Cook County earlier this year is an estimate only. it is always 55% of last year’s bill and doesn’t take into account any new tax rate, exemption, reassessments or other factors that might impact a tax bill. The second installment is where the action is at.
In most instances, a policy of efficiency calls for a proration based upon some percentage of the most recent full year tax bill (taking into account any funds actually paid). Commonly, in Chicago, the customary proration percentage is 110%. Let’s say the 2014 taxes are $1000 and the contract calls for a 110% proration. Under such a system, the calculation for 2015 taxes for a closing that takes place on April 1, 2106 works like this:
$1000 tax bill
$1100 -$550 amount of first installment
$550 credit to buyer for real estate taxes for 2015
So, the seller pays the real estate buyer, by way of a credit against the sale price, $550 for 2015 taxes and the tax bill now belongs to the buyer. When it comes out in July, if the bill is $1000, the buyer pays the bill and comes out $100 ahead. If the bill is $1200, the buyer pays the bill and is down $100.
A similar exercise is done for the 2016 real estate tax proration:
$1000 tax bill
÷ 366 days in 2016
$3.00 per day tax bill
x 92 days in 2016 that seller owned the real estate
$276.00 credit to buyer for real estate taxes for 2016.
So, the seller pays the real estate buyer, by way of a credit against the sale price, $276 for 2016 taxes and the 2016 tax bill now belongs to the buyer. This is usually viewed as a “good” way to do it. Is it perfect? No, but the parties don’t have to wait around until 2017 to find out what everyone’s fair share was. The parties don’t have to put money into escrow. The parties don’t have to track each other down. The parties don’t have to pay their attorney’s more money for getting involved in a post-closing issue (boo!).
But, what about taxes for a year like 2015 where we have lots of unanswered questions and lots of worries? Well, a buyer could just negotiate for a higher proration amount (maybe 125%?) and continue to take the risk that the new bill could be more or less. But, is there another way? There is. It’s a bit more complex and not as efficient and the parties need to stay connected and it can cost a few bucks, but it is based on fairness. That way is to reprorate the taxes after the actual bill is known. In such a scenario, a proration is made at some reasonable amount at the closing table (maybe 100%, maybe 110%). Then, the seller is asked to deposit some additional money into an escrow account with the title company or the seller’s attorney. Once the tax bill is known, the parties get back together and compare. Did the buyer get enough? No? Then the seller pays the buyer any amount due from the escrow. Did the buyer get too much? If so, the buyer pays the seller back. It’s not efficient, but it does ensure that the parties pay their fair share.
There’s also a hybrid. So that the parties don’t have to stick together until 2017 (when the 2016 bill is known), the parties can employ a hybrid between the policies of efficiency and fairness. For fairness sake, the parties can take a small proration, deposit funds, and do a reproration once the 2015 full year tax bill is known. 2015 is where the most risk lies. After all, the 2016 bill will be based upon a similar assessed value as the 2015 bill. In such a case, maybe the parties agree at that same time to reprorate the 2016 taxes based upon 110% of the 2015 bill. That means that the parties only need to stick together a few months after the April 1, 2016 closing. Not a horrible deal and the buyer cuts down the risk with regard to the 2015 taxes, gets a “more fair” 2016 proration, and is able to get things over within a relatively short period of time.
Use an attorney for your Cook County or Chicago, Illinois real estate closing
I know. Original advice, right? Well… I think its a good idea. These kinds of issues come up all the time and an experienced real estate attorney has ideas about the possible ways to deal with them. It is an uncertain world and most people only do a few real estate deals in their lifetime. Would you go white-water rafting on the Colorado River without a guide if you did it a few times in your life? I hope not. A real estate attorney can help, especially in this crazy world. Give us a call and we can see if we are a match to help you with your closing. We represent buyers and sellers in both the City of Chicago and the suburbs. In fact, here’s a secret, we representing purchasers and sellers in Lake and DuPage County too!