Are Real Estate Taxes Going to Wreck Your Investment? | Hahn Loeser & Parks LLP

Homebuyers often fail to account for the increased taxes associated with their estimated selling price when applying pro formas to cash flow. In Ohio, the sale price is considered fair market value for property tax purposes. Prudent buyers should estimate and prorate taxes using the selling price as the basis for the value of their investment. Otherwise, a “standard” proportioning provision in the deed of sale will force the buyer to pay the tax increase themselves, even for that part of the year the property was owned by the seller.

As real estate values ​​continue to rise at historical rates, real estate taxes can be a hidden trap when trying to figure out numbers for what appears to be a safe real estate investment. Prudent investors should analyze their potential real estate deals based on cash flow, which is the money that will be generated from the remaining property after all expenses including property taxes have been paid. But in many states, like Ohio and Illinois, property taxes are paid in arrears. This means that taxes for the current year are not due and paid until the following year and the amount due is often affected by the purchase price of your future business. This alone creates a lot of confusion when it comes to properly analyzing a real estate investment, including evaluating the possibility of a new, increased tax burden on the property.

What many are unaware of is that property taxes are in many cases determined based on the purchase price of an arm’s length transaction. So if your prospective property is currently valued at $2 million by the CPA for property tax purposes and you plan to offer a purchase price of $8 million, you can expect a large increase in the property’s property taxes to take effect for the current year, but due and payable in the following year. Many investors, even the most savvy, can forget about this increase by relying on the current tax bill for their cash flow calculations, or grossly underestimate the potential tax burden increase. This can lead to overpayments on investments and (gulp!) negative cash flow.

So what can be done to ensure you have solid calculations for your potential investment? Always check with the county auditor first to determine the current market value as determined by the auditor for tax purposes. This is public information that is easily accessible online. Second, if your proposed purchase price is higher than the accountant’s market value, you can usually expect your property taxes to increase based on the sale. To determine the new tax burden, many counties have online calculators that can be used to estimate the new property tax amounts. However, if no tax calculator is available, you can simply divide the current tax calculation by the current market value determined by the auditor and get the current tax percentage. Then apply the current tax percentage to your proposed purchase price, and voilà! – You have your new estimated tax bill.

Another issue investors should consider when calculating numbers and determining the best purchase price for a real estate investment is whether there are tax breaks for the property. A tax reduction is an exception to property taxes – meaning none apply. Tax reductions can be given for the whole value of the property or for a part. However, it is important to note that tax breaks are usually for a specific period of time. Therefore, you want to know when the tax reduction was granted and how long it will last. Then you must calculate the new tax burden based on your proposed purchase price and determine when those taxes ultimately apply.

Finally, when buying a new property, you should consider requiring favorable terms in the purchase agreement in relation to the transaction structure and/or the tax portion paid by the seller at closing. Because Ohio taxes are paid in arrears, buyers typically receive a daily credit from the seller at closing for that portion of the year that the seller owned the property. This proportion is common because the tax bill for the year the seller owned the property is paid in full by the buyer when it finally becomes due the following year. So if the tax burden increases based on the selling price, but the seller’s prorated credit is based on the lower existing tax burden, you won’t get a fair credit for the period that the seller owned the property. There are also ways to creatively structure a business to try and dodge a big tax hike. However, these strategies are not guaranteed to work, so the new tax burden should still be factored into your bottom line. It’s important to address these property tax issues before or at closing, as many standard sales contracts make the proportion final at closing. Even if there is language that permits recalculation of the tax proportion after closing, merger doctrine, which states that all matters of the contract of sale go into the deed at closing, may preclude such a proportion if no specific language is included in the deed to preserve the output.

Property taxes can get complicated, but help is here! Before closing the deal on that new investment property, don’t hesitate to consult an experienced real estate attorney to guide you through the tax issues and pitfalls!

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