16.7 Allocating Taxes When You Sell or Buy Realty
When property is sold, the buyer and seller apportion the real estate taxes imposed on the property during the “real property year.” A “real property year” is the period that a real estate tax covers. This allocation is provided for you in a settlement statement at the time of closing. If you want to figure your own allocations, your local tax authority can give you the “real property year” of the taxes you plan to apportion. If you are the seller, you deduct that portion of the tax covering the beginning of the real property year through the day before the sale. If you are the buyer, you deduct the part of the tax covering the date of the sale through the end of the real property year.
The allocation of taxes between the buyer and seller is mandatory whether or not your contract provides for an allocation. However, you do not allocate taxes of a real property year when property is sold before the real property year. This rule prevents the seller from deducting any part of the tax for that year, even though it became a personal liability or lien while he or she owned the property. The buyer gets the deduction because he or she owns the property for the entire real property year. You also do not allocate taxes when property is sold after the real property year. This rule prevents the buyer from deducting the tax for that year even though it becomes a personal liability or lien after he or she takes possession of the property. The seller gets the deduction because the tax covers the property year in which the seller owns the property. The allocation is limited to a tax covering a property year during which both the seller and the buyer own the property.
Form 1099-S.
If Form 1099-S is filed by the mortgage lender or real estate broker responsible for the closing, Box 5 will show the buyer’s share of the real estate tax paid in advance by the seller. For example, Smith sells her house in Green County, where the real estate tax is paid annually in advance. In the year of sale she paid $1,200 in real estate taxes. Assuming that the home is sold at the end of the ninth month of the real property tax year, the amount of the real estate tax allocable to the buyer is $300 ($100 per month × 3 months). This amount, which is shown as paid by the seller in advance on an HUD-1 (Uniform Settlement Statement) form provided at the closing, is reported as the buyer’s share of the real estate tax in Box 5 of Form 1099-S.
IRS Alert
When to deduct allocated taxes.
After you have made the allocation based on the “real property year,” you then must fix the year in which you deduct your share of the allocated tax. Here you consider your method of reporting your income—cash or accrual basis—and the date on which either you or the other party became liable for the tax or paid the tax. If neither you nor the other party is liable for the tax under local law, then the party who holds the property at the time the tax became a lien on the property is considered liable. Check the following rules to determine when you deduct the apportioned tax:
Seller on the cash basis—If the buyer is liable for the tax under local law, the seller may deduct his or her share of the allocated tax either in the year of the sale or a later year when the tax is actually paid. If the seller is liable for the tax under local law, and the tax is not payable until after the sale date, the seller may deduct the tax either in the year of sale or in the year he or she pays the tax.
Buyer on the cash basis—If the seller is liable for the tax under local law, the buyer may deduct the tax either in the year of sale or when the tax is actually paid. If the buyer is liable for the tax, he or she deducts the tax in the year the tax is paid.
Seller on the accrual basis—The seller accrues his or her share of the tax on the date of the sale, unless taxes have been accrued ratably over the years. If this is so, the last accrual is the sale date.
Buyer on the accrual basis—If the seller is liable for the tax, the buyer accrues his or her share of the tax on the date of the sale, unless taxes are accrued ratably. If taxes are accrued ratably, the accrual begins with the date of sale. If the buyer is liable for the tax, he or she deducts the tax in the return for the year the tax accrues unless an election is made to accrue ratably from the date of sale.
Filing Instruction
Seller’s deduction in excess of the allocated amount is taxed.
If, in the year before the sale, the seller deducts an amount for taxes in excess of the allocated amount, the excess must be reported as income in the year of the sale. This may happen when the seller is on the cash basis and pays the tax in the year before the sale.
Buyer may not deduct payment of seller’s back taxes.
If you agree to pay the seller’s delinquent taxes as part of your purchase, the back taxes paid are added to your cost of the property. The amount realized on the sale by the seller is increased by your payment of the back taxes.
Seller’s payment upon buyer’s failure to pay.
If a buyer is obligated to pay taxes under a land contract but fails to pay, the owner who pays the tax may deduct the payment if the tax is assessed to him or her.
Buyer of foreclosed property.
If you buy realty at a tax sale and you do not receive immediate title to the property under state law until after a redemption period, you may not be able to deduct payment of realty taxes for several years.