The Difference Between Standard Tax Proration and Tax Reproration in Commercial Real Estate Deals
When buying or selling commercial real estate, there are many important clauses in the purchase and sale agreement that allocate economic responsibilities between the buyer and seller. One such clause deals with the proration of property taxes.
What is Tax Proration?
Property taxes are usually paid in arrears, meaning the taxes paid in any given year are for the prior year. Because of this lag between assessment and payment, buyers and sellers need to agree on a fair allocation of taxes when the property changes hands. Tax proration is the process of dividing tax liability so each party pays their fair share based on the portion of the tax year they owned the property.
Standard Tax Proration
The standard tax proration clause simply splits the most recent assessed tax bill based on each party’s ownership period. For example, if the seller owned the property from January 1st through September 30th and the annual tax bill was $100,000, the seller would be responsible for 9/12 ($75,000) and the buyer would pay the remaining 3/12 ($25,000).
While simple, this approach relies on the accuracy of the existing tax bill and provides no protection against reassessment. If taxes go up after closing, the buyer bears the full increase even if some of it relates to the seller’s period of ownership.
Tax Reproration Clause
With a tax reproration clause, the parties agree to re-allocate responsibility for any increase or decrease in taxes after closing based on each party's ownership period.
If the assessed value was increased on January 1st prior to sale, a portion of the increase would relate back to the seller's ownership. A tax reproration clause requires the seller to pay their share of any such retroactive increases. This provides important protection to the buyer.
Conversely, if taxes decrease, the buyer would owe the seller a refund for taxes overpaid during the seller’s ownership period. This clause works both ways to achieve a fair allocation.
Key Benefits of Tax Reproration:
- Protects the buyer from being solely responsible for retroactive tax increases relating to the seller's period of ownership
- Allows the seller to benefit from obtaining refunds if taxes are later decreased for their ownership period
- Allocates responsibility based on actual taxes paid rather than estimates
- Reduces disputes down the road as new assessments come in
Standalone Tax Reproration Agreement
Rather than including tax reproration in the purchase and sale agreement, sometimes the parties will elect to use a standalone tax reproration agreement. This separate contract provides more flexibility to designate custom time periods, allocation methods, and procedural requirements compared to the standard clause. It also keeps the primary purchase agreement cleaner.
The Takeaway