This article is intended for educational purposes only and not as legal advice
November 6, 2015
Although at first blush it would appear that you cannot go wrong pro-rating property taxes using the most recent mill levy and assessed value, it can lead to an extremely unfair pro-ration. Here’s a cautionary tale: I was involved in a transaction with a seller (plat never vacated with issues I solved) that made massive improvements to the home taking it from approximately 7 million to 13 million in value. The Realtor acted as a transaction broker. The seller and buyers were both represented by attorneys. The buyers’ attorney either prepared or reviewed the contract written by the transaction broker, and it provided for taxes to be pro-rated using the most recent mill levy and assessed value. A few months after closing, the new buyers received their property tax bill from the county, and it was tens of thousands higher than the amount used for pro-ration. The unfairness of the pro-ration was exacerbated by the property closing late in the year. Needless to say, they weren’t happy with their attorney nor the transaction broker.
So, what went wrong? The seller made many millions of dollars of improvements to the home before selling it. The county all along had the property scheduled to be re-assessed just 2-3 weeks after the closing and prior to billing the present year’s taxes which we all know in Colorado are paid in arrears. The transaction broker and buyer’s attorney could have easily found that fact out by making a quick call to the Assessor.
Commercial deals regularly defer the final settlement/pro-ration of taxes until the actual bill comes out because of the large amounts of money involved. Residential transactions almost always involve final settlement. Besides the option of treating it like a commercial deal and pro-rating taxes once the actual amount is known, another simple solution to achieve a fair final settlement is to contact the assessor and find out whether they’ll use the new value for the entire year or once the improvements are completed. Then, just take the average taxes for 3-5 similarly priced homes in the same county and put that amount in the contract to be used for purposes of pro-rating with any adjustment made for whether it will be the value for the entire year or just after a certain date. This will lead to a final tax settlement that will be very close to what it would be when the actual amount is known. It would have worked great in the case discussed above.
Here’s another important property tax pro-ration tip regarding new construction: Many builders in their custom sales agreements address the tax pro-ration issue by using the previous year’s taxes for obvious reasons. That’s certain to lead to a very unfair pro-ration in favor of the builder/seller since typically the property was either a mere lot or just partially constructed the previous year. Even if the builder/seller pro-rated based on the current mill levy and assessed value, like the story above, the assessed value could still be based on just a lot or a partially constructed home. But, the County Assessor is going to re-assess the home once completed for a far higher amount and likely before the next tax bill. This often leads to the builder/seller paying far less than what is fair for the builder’s portion of the year’s taxes. Although I’ve witnessed buyer’s attorneys get angry and adamant at the closing despite what the contract stated and successfully force the builder to change the pro-ration, I recommend addressing this issue on the front end and amending the tax pro-ration provision of the sales agreement accordingly. Builders will bend regularly on many of their contractual provisions since they know that most are one-sided in their favor. Few people try to challenge any of these provisions, but when they do, they’re often successful since the builder still wants to make a sale and knows the buyer is likely making a reasonable request.