How Property Tax Works When Buying a House
Gain a clear view of your property tax obligations as a new homeowner, from how they're addressed at closing to managing payments after you move in.
Property tax is a tax on real estate levied by local governments to fund public services. When purchasing a house, understanding how these taxes are handled is a component of managing the financial responsibilities of homeownership. The process involves several stages, from the initial calculation to adjustments that can occur after the sale is complete.
How Property Taxes are Calculated
Your annual property tax bill is based on two components: the property’s assessed value and the local tax rate. A municipal assessor determines the assessed value, which is not the same as the market value—the price you paid for the house. It is a percentage of the market value used for calculating taxes, and this percentage can vary by location as each municipality sets its own rate.
Local governments establish a tax rate, sometimes called a millage rate. A mill represents $1 of tax for every $1,000 of assessed value, and these individual rates are combined to create the total rate applied to your property. For example, if your home has an assessed value of $300,000 and the total tax rate is 1.2%, your annual property tax obligation would be $3,600.
Property Taxes at Closing
The handling of property taxes at closing is a process of proration, ensuring a fair division of the tax liability between the buyer and seller. Proration splits the annual tax bill based on the number of days each party owns the property during the tax year. The seller is responsible for the taxes up to the closing date, and the buyer is responsible from that day forward.
The mechanics of proration depend on the local tax cycle and whether taxes for the current period have been paid. If the seller has prepaid taxes for a period that extends beyond the closing date, the buyer will credit the seller at closing. Conversely, if the tax bill is due after closing, the seller will credit the buyer for their portion of the tax bill. These financial adjustments are itemized on the Closing Disclosure document.
This proration is based on the previous year’s tax amount, as the current year’s official tax bill may not have been issued at the time of closing, making the prorated amount an estimate. The purchase contract will specify the method used for this calculation.
Methods of Paying Property Taxes
New owners have two primary methods for paying ongoing property taxes. The most common is through an escrow account managed by the mortgage lender, where a portion of your monthly mortgage payment is deposited to cover future property tax and homeowners insurance bills. The lender estimates your annual costs, divides that total by 12, and adds the amount to your monthly mortgage payment.
This combined payment is known as PITI (Principal, Interest, Taxes, and Insurance). When property tax bills are due, the lender uses the funds in the escrow account to pay the local tax authority on your behalf. Lenders conduct an annual analysis of the escrow account to adjust for changes in tax rates or insurance premiums, which can result in a surplus refund or a shortage.
The alternative to an escrow account is direct payment. The homeowner is responsible for budgeting for and paying the property tax bills directly to the municipality when they come due. This option requires financial planning to cover a large, semi-annual or annual expense, and some lenders may require a down payment of 20% or more to waive an escrow account.
Post-Purchase Tax Adjustments
A home sale frequently triggers the local tax authority to reassess the property’s value based on the new purchase price. This can lead to a higher assessed value compared to the previous owner. Consequently, the property tax bill for the following year may be higher than what was anticipated based on the seller’s prior payments. This “uncapping” of the taxable value is a standard procedure in many jurisdictions.
This reassessment can result in a supplemental tax bill, a one-time charge that covers the difference between the old tax amount and the new one for the remainder of the tax year. This bill is sent directly to the new homeowner and is not paid out of an escrow account. Depending on the timing of the sale and reassessment, a new owner might receive two supplemental bills.