Proration of taxes: Overview, definition, and example
What is proration of taxes?
Proration of taxes refers to the process of dividing or allocating taxes between two or more parties based on a specific time period or other relevant factors. This is typically done when ownership of a property or asset changes hands during the year, and taxes are assessed on an annual basis. Proration ensures that the party responsible for the property during a given period pays the taxes for that time, even if the tax year doesn't align with the transaction or ownership change. For example, if a property is sold halfway through the year, the buyer and seller may agree to split the property taxes based on the portion of the year each party owned the property.
Why is proration of taxes important?
Proration of taxes is important because it ensures a fair and equitable distribution of tax obligations when ownership changes mid-year or during a partial tax period. Without proration, one party may end up unfairly paying the full year’s taxes, despite only owning the property or asset for part of the year. Proration helps prevent disputes between buyers and sellers or other parties involved in property transactions by ensuring that each party pays taxes based on their actual period of ownership.
For real estate transactions, proration of taxes is a standard practice to ensure that the seller pays taxes for the period they owned the property, and the buyer is responsible for taxes from the date of purchase onward.
Understanding proration of taxes through an example
Let’s say a homeowner sells their property on July 1st. The annual property tax for the property is $1,200, due to be paid at the end of the year. Because the seller owned the property for the first half of the year, and the buyer will own it for the second half, the taxes must be prorated.
In this case, the seller is responsible for paying taxes for the first six months of the year, and the buyer will be responsible for the second half. To calculate the proration, you would divide the total annual property tax ($1,200) by 12 months, giving you $100 per month. Since the seller owned the property for six months, they would pay $600, and the buyer would pay the remaining $600.
Example of a proration of taxes clause
Here’s how a proration of taxes clause might appear in a real estate contract:
“The parties agree that the property taxes for the current tax year shall be prorated between the Buyer and Seller based on the closing date of the sale. The Seller shall be responsible for property taxes up to and including the day of closing, and the Buyer shall assume responsibility for property taxes from the closing date forward. Any amounts owed for taxes shall be calculated and adjusted at the closing, and any overpayment or underpayment shall be settled between the parties.”
Conclusion
Proration of taxes ensures that the tax burden is fairly divided when ownership of property or assets changes during the year. This practice helps avoid disputes over who is responsible for paying taxes and ensures that each party pays for the period they owned the property. Whether in real estate transactions or other cases of partial ownership during a tax period, proration provides a clear method for distributing tax liabilities based on the length of ownership or other relevant factors. Understanding how proration works is key to ensuring fair and accurate tax payments in such situations.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.