REAL ESTATE TAX CONSIDERATIONS FOR COMMERCIAL REAL ESTATE PURCHASE AND SALE AGREEMENTS
Since real estate taxes are always due after the period to which they relate (e.g. taxes for 2019 are not due until 2020) every real estate purchase and sale agreement contains a provision governing the proration of real estate taxes between the parties for pre-closing and post-closing periods. The general allocation of responsibility for real estate taxes seems simple and fairly non-controversial – with sellers paying for all taxes attributable to periods prior to closing and purchasers being responsible for all taxes attributable to periods after closing. When negotiating for the purchase and sale of commercial real estate, however, the parties must give sufficient consideration to a number of issues which can complicate proration provisions and which could interfere with the parties’ achieving a fair division of real estate taxes.
Timing of Closing/Actual vs. Estimated Taxes
The method of calculating the real estate prorations is dependent upon the time of year in which the closing occurs. For instance, the proration calculation method will vary based upon whether the actual tax bill for the fiscal period in which the closing occurs has been issued or whether the parties need to prorate taxes based on an estimated tax bill. In many jurisdictions, such as Illinois, taxes are payable in arrears, meaning that the tax bill in any calendar year will relate to taxes for the prior calendar year. For example, a seller and purchaser closing on the sale of a commercial property located in Cook County, Illinois in April will not know the amount of the final tax bill for the closing year until the following July – some 15 months later. In such a scenario, the parties will need to negotiate a proration provision in which the seller reimburses the purchaser for an unknown amount of real estate taxes which will be payable after closing but which relate to the seller’s period of ownership prior to closing. Often, those estimates will be based upon the last known tax bill increased to reflect an assumed annual increase in taxes, e.g., taxes are prorated based upon 110% of the prior year’s taxes.
Property Tax Reassessments
The timing of the issuance of real property tax assessments in relation to the closing date will need to be figured into the proration calculation. If the property has been reassessed for real estate tax purposes for the calendar year in which the closing occurs, the increase in the assessment should be factored into the proration calculation. For example, if the assessed valuation of the property increases by 25% for the closing year but the actual tax bill is not known as closing, an estimated tax bill calculated based on 110% of the prior year may lead to an insufficient proration from the purchaser’s perspective.
Moreover, the parties should also consider factors which may result in an increase the assessed valuation which will be used in calculating the final tax bill. For example, if a seller benefitted from a temporary reduction in assessed valuation in the prior year’s taxes based upon circumstances that no longer exist (e.g., a large vacancy factor in the prior year or a tax incentive exemption), the parties may wish to calculate the proration based upon the assumption that the temporary reduction will no longer exist. Properties which have yet to be assessed for real estate tax purposes (e.g., new construction) also present a challenge to the parties for fairly calculating tax prorations.
Property Tax Assessment Appeals
Another issue for consideration is the timing for the appeal of real estate tax assessments relating to the closing year. Since each of seller and purchaser may be responsible for payment of portions of the closing year’s taxes, the parties will need to consider whether seller or purchaser will take responsibility for appealing the real estate taxes and the manner in which the cost of those appeals will be calculated.
Tenant Tax Reimbursements
An often overlooked issue is whether commercial tenants are obligated under their leases to reimburse the landlord for all or a portion of the annual real estate taxes. If the landlord is collecting estimates for real estate taxes from the tenants, the parties will need to include the estimated payments in the rent prorations and adjust the tax proration to account for tenant payments. A review of the leases will be necessary to determine whether the landlord is obligated to reconcile the tenants’ estimated tax obligations and the actual obligations once final bills are issued. If there is a tax reconciliation after closing, seller and purchaser will need to address these obligations as part of the rent proration.
Reproration Agreements
Given the number of complicating factors which may exist in fairly prorating real estate taxes, sellers and purchasers often will resort to negotiating and signing an agreement to reprorate taxes after closing when final tax bills are issued with respect to the closing year. These agreements will often result in the parties reaching a correct result but may require the parties to remain engaged for long periods of time after closing. As with all other aspects of commercial real estate agreements, the benefits of a certain result at closing versus the need for the parties to reengage after closing will need to be determined.
If you have any questions regarding real estate issues, please contact Jeffrey M. Galkin, at 312-368-0100.
