Death and Taxes - The Blog: Sherwin Abrams on Real Estate Taxes

Property taxes in Illinois are paid in arrears -- '05 taxes get paid in '06, '06 taxes get paid in '07, and so on. To make matters worse, in Cook County you have to wait for the second installment tax bill to come out in order to figure the whole year's taxes, since the first installment bill is always 50% of the previous year's taxes.

This weird way of handling real estate taxes makes it difficult on sellers and buyers of real estate (and their attorneys). Sellers of real estate typically give buyers a prorated credit at closing for real estate taxes, because the buyer will be receiving tax bills for time periods when he or she didn't own the home. Determining the amount of this credit involves a LOT of guesswork and negotiation. Do we assume that taxes will increase by 5%? By 10%? By more (or by less)?

I belong to a transactional law e-mail group made up of members of the Illinois State Bar Association (ISBA). Today, a Chicago attorney named Sherwin Abrams presented a thoughtful and fairly revolutionary post about these tax prorations. Mr. Abrams' post also makes some interesting comments about the state of residential real estate transactions. Mr. Abrams has graciously agreed to allow me to present his post in full -- here it is:

Why do we make such a big deal about prorating real estate taxes? Would not life be simpler if we changed our practice so that the seller paid all taxes that were due and payable prior to closing and the buyer paid all taxes that become due and payable after closing? In other words, let’s abolish prorations.

Not fair, you say. It is the 2005 taxes that are paid in 2006, and the seller should pay the taxes that accrued while he/she owned the property. But what’s in a name? Does it matter that we say that it is the 2005 tax that is being paid in 2006? What if we call the tax that is paid in 2006 the 2004 tax or the 2007 tax? The fact is that tax must be paid in 2006, and we do not expect there ever to be a year when there is no real estate tax.

Even if you hold to the fiction that we are always paying last year’s taxes so that it would be unfair to the buyer not to prorate, everything will even out when this year’s buyer becomes next year’s seller. Not having received a credit when he/she bought, our buyer would not have to give a credit when he/she sells.

Even if you are not willing to eliminate prorations altogether, it does not make much sense to argue over the amount of the proration. OK, you might agree, in most years taxes are not going to change all that much so that it costs more to make an issue of whether the proration should be at 105% or 110% than it is worth. But what about years when the tax might increase by as much as 50%? Yes, indeed, the buyer should be wary of buying when taxes might jump, but not just for the year of purchase. The buyer should be concerned with whether he/she will be able to pay the taxes in all the years to come when that 50% increase will remain in effect.

No, I do not expect the bar to change its practice so that we can rid ourselves of this unnecessary complication to what used to be called a simple house closing, no more than I expect another of my proposals to be widely adopted: namely, that the buyer should choose and pay for his/her own title insurance just as the buyer chooses and pays for his/her own home inspector.

Let me warn you, though, that the residential real estate practice is broken. Negotiations are too contentious; contracts are too complicated; mortgage documentation is too voluminous; closings take too long and are too stressful. The entire process of buying a home is much too expensive. If the lawyers and the brokers and the lenders and the title companies do not try to do something to simplify the process, the People, acting through their duly elected representatives, will. And that will make matters even worse.