Realty Tax Adjustments Explained
Many people are confused about tax adjustments done by their lawyer in handling their house purchase or sale. I hope to show you in this short article what a tax adjustment is, how it is done, and why it is a good thing for purchasers without causing any harm to vendors.
Realty Taxes are the annual taxes charged by the city, town or municipality where your property is located. They are used to fund local services and schools. Net realty taxes are the total realty taxes for the year, less any deductions, such as the Resident Home Owner’s Tax Advance.
It’s October, Aren’t My Taxes Already Paid for the Year?
Because tax bills for towns and rural municipalities are usually mailed in May or June (earlier in most cities) and are payable without interest or penalty until September or October depending upon the municipality, (also earlier in most cities,) people often think their tax payment covers the time period from September to September or October to October, as the case may be. This is a common misconception. Actually, taxes are for the calendar year, from January 1st to December 31st, inclusive. So, in effect, you are billed for and pay your taxes in the “middle” of the year for which they are payable.
What Exactly Is a Tax Adjustment?
A tax adjustment is done to allocate or divide the realty taxes for the year between the seller (vendor) and the buyer (purchaser) according to the date agreed upon in the accepted Offer to Purchase. Therefore, if the taxes are adjusted as of January 1, there is no adjustment. One party pays all of the taxes for that year. This is often the case with agricultural property where the “profit” for the year’s production goes only to either the seller or the buyer, depending on when the land changes hands. The general principles is, “whoever takes the profit for the year, pays the taxes.”
If taxes are adjusted as of any date other than January 1, however, it becomes necessary to calculate the amount that each of the buyer and seller will be obliged to pay. This is the customary procedure with residential and commercial property.
Although some law firms calculate tax adjustments by month or half-month, most prefer to adjust using the actual number of days for which each side will be responsible.
The formula is:
“Net Taxes times the Number of Days from January 1 to the Adjustment Date divided by 365 (366 in a leap year.)”
The result is the portion of the yearly taxes which are must be paid by the seller. If you need to find out how much the buyer owes, it is a simple matter to subtract the amount the seller owes from the net taxes for the year.
Who Pays Who?
If the adjustment date occurs before the seller has paid the year’s taxes, the actual payment of the adjusted amount is usually handled by subtracting the amount of taxes the seller owes from the amount the buyer is paying for the property. In effect, the buyer “keeps the money in their pocket.” Put another way, the seller pays their taxes for the year by leaving the money with the buyer. The buyer then, in effect, takes the seller’s money, together with their own money, and pays the taxes to the city, town, or municipality when they come due (in September, for example.) The buyer, then, pays all of the net taxes for the year when they come due, in part with their own money and in part with the seller’s money.
If the adjustment date occurs after the seller has paid the year’s taxes or at a time when there would not be enough time for the buyer to pay the taxes after the adjustment date, allowing for the time necessary to record the change of ownership at the Land Titles Office, then the seller provides proof they have paid all of the taxes and the buyer pays the seller back, or reimburses them, for the buyer’s share of the year’s taxes.
In both cases, this is done through the lawyers representing the buyer and seller.
I’m a Buyer, Why Would I Want to Adjust?
As a buyer, you will derive the greatest benefit from having realty taxes adjusted as between you and the seller.
First, you do not need to worry about whether the seller has paid their share. Sure you might get a copy of a receipt, but how do you know the seller’s cheque didn’t “bounce?” How do you know the seller didn’t make up a “forged” receipt?
When taxes are adjusted, you know they are paid because you have the seller’s money in your pocket. With a little diligence, you can be absolutely sure the payment gets made, because you make it yourself.
Second, you get to keep the seller’s share of the taxes in your pocket and, as long as you make sure you have money together for the due date for taxes, you can “borrow” from this money for those unexpected expenses that often come up, such as moving costs, appraisal fees, loan approval fees, land transfer taxes and…yes…legal fees and disbursements. Were it not for the tax adjustment, you would need to pay the full purchase price of the property right on the possession date and would not be able to delay any part of it, except by obtaining a mortgage loan.
All things considered, tax adjustment is a pretty good deal for the buyer.
I’m a Seller, What’s In It For Me?
You don’t need to go to the town hall to pay your share of the taxes, but your lawyer would probably handle that part anyway. Also, if you happen to pay the whole tax bill, there is usually a “time lag,” during the time the change in ownership is being recorded at Land Titles, before you get the buyer’s share back. Other than that, the best part of tax adjustments is you are probably buying a new home yourself, and will enjoy the buyer’s advantages, or at least you my buy again sometime.
Are There Any Risks?
The biggest risk, with our busy lives, is that the buyer will forget about paying the taxes when they come due.
In the year when the sale occurs, it is quite common for the tax bills to go to the seller, or he may already have them. Although there is a system in place for the Land Titles system to notify the Assessment system to update their records, it takes time for the new information to “work its way thorough.” Also, because of the number of tax bills that need to be printed each year, the bills are often already printed by the time the new information reaches the Assessment Branch, even though the bills have not actually been mailed.
The seller, even if they are “nice guys” and would send the bill to you, may forget, or they may have moved far away. After the seller has been told by their lawyer that they do not have to pay any tax bills for the year of the sale, most of the bills wind up in the garbage.
As a matter of practice, I advise clients to mark their calendars to check with the town office well in advance of the tax due date. I recommend to them that they do so immediately when they go home from my office.
In rural sales, I generally suggest they mark their calendar for the end of July or early August, as all tax bills should be out by that time and it is early enough to catch the earlier rural due dates. In cities, you should check much earlier, as taxes are often due in June. In any event, you should be guided by your lawyer’s advice and, please, be very careful not to let this “slip through the cracks.” This is particularly true now, when tax penalties and tax sale proceedings have become much more severe.
What About the Exceptions?
There are many exceptions to the rule. Some people pay their taxes early to take advantage of discounts offered by municipal governments. Some people pay monthly, where that is available. Also, some lawyers insist upon calculating the amount due by the seller and having the seller make part payment to the municipality. In the end, the only safe procedure is to be guided by your lawyer’s advice.
Apart from the exceptions, however, it is generally best to adjust.
I Paid My Taxes With My Mortgage, Where Did They Go?
Essentially what happens is that the lender accumulates the payments in an account so they have money on hand to pay the taxes to the municipality on the due date. If you sell before they pay the taxes, the lender usually just applies the money in the account to the amount of the mortgage, which reduces the amount of money that the lawyer has to pay from the sale proceeds to pay off the seller’s mortgage. In this case, we just do an ordinary adjustment as we have explained above.
Very occasionally, however, if the buyer and the seller deal with the same mortgage company, they may try to assign over the money in the tax account. This can cause all sorts of trouble but, as always, be guided by your lawyer, whose job it is to sort these things out.
I Am Going To Pay My Taxes With My Mortgage, So I Don’t Have To Do Anything…Right?
In most cases, there will not be enough time to build up sufficient money in the tax account to pay the taxes for the year of the sale, unless you either make huge tax payments with each mortgage payment, which might be a hardship, or unless you pay a large sum into the tax account right away to “catch up” for the months of payments you would have made since the previous tax due date if you had been making mortgage payments on the property throughout that time. While there is nothing wrong with this and, if you have the money, you might as well take care of the payment, for most people having use of the money for a few weeks or months is the best option. It is usually easier to put the additional tax money aside after the costs of buying, moving, and so on have been taken care of.
Our Sale Occurred Before We Knew What the Taxes for the Year Would Be, What Should We Do?
If your lawyer could not know the exact amount of the taxes because the sale was before the bills came out, the taxes amount was probably estimated using the prior year’s tax bill. The actual taxes for the year could be more or, rarely, less than the amount estimated. If the difference is large enough, there is sometimes a readjustment done after the actual tax amount is known. In most cases, however, the difference simply would not be worth the cost of the additional work. Once again, be guided by your lawyer’s advice.
The foregoing presented a brief overview of the topic of realty tax adjustments. There are many additional and quite intriguing questions such as, “Why do you adjust using net taxes and not gross taxes?” and “Who pays the taxes for the date ownership changes?” which I must leave to another day. I hope this brief, “tax adjustment in a nutshell” sheds some light on a process which can be rather confusing at times. I hope this article will help you to understand what your lawyer is doing on your behalf and why it is done the way it is.
Revised May 24, 2003