What Does "Paid in Arrears" Mean Related to Property Taxes?

Anyone under the impression that paying in arrears is not a good way to handle their finances is right in many cases. Generally, when someone pays in arrears, it means they pay their bill late. Paying property taxes in arrears is an entirely different matter, however. Many people don't understand this, since property taxes are often handled by their lender. But when it comes time to sell the property, the issue of property taxes is important and can be confusing.

Property taxes are taxes imposed by a state or local government on real property owned by an individual or other legal entity. Often, these taxes are ad-valorem taxes, calculated by the taxing authority based on the value of the property, including the land on which a building is situated and all other structures on the land.

A property owner gets a tax notice every year. The amount of the property tax bill is calculated by multiplying the applicable property tax rate times the current value of the real estate. A tax assessor will usually determine the fair market value of the property annually, and that becomes the home's assessed value. For example, if a real estate tax rate is set at 1 percent, and a house has an assessed fair market value of $500,000, the home owner's annual property tax for that year will be $5,000.

Each state sets its own schedule and due date for property tax payments. Many states assess property taxes at the beginning of the tax year, but bill the amount due in two payments, due about six months apart.

For example, the first payment, for the first half of the tax year, may be due in June or July. The second payment for the second half of the tax year, may be due in December. But – and here's the "arrears" catch – the two payments billed in the current year may be for the property tax the year before.

Many states organize their real property taxes so that they are paid in arrears. This does not mean that the payments are not timely. Rather, it means that the state bills a homeowner during the current year for property taxes that are attributable to owning the house in the prior year.

When a taxpayer makes a timely payment this year, it is to cover a period that has already passed. That is what is meant by paying property taxes in arrears. To confuse matters more, in some states payments are partially in arrears and partially in advance.

Many states have property taxes that are paid in arrears. Ohio is a good example. Property owners in Ohio pay their first property tax installment in June or July, depending on the county that their home is in. These summer payments cover the property taxes a homeowner owes for the payments in a unique (and sometimes confusing way). The property taxes are paid for the prior year. That is, the payment in summer 2022, will cover the amount of taxes owed for the period July 1, 2021, through December 31, 2021. The second property tax payment, late in the year, covers the tax for the first half of 2022.

Another example of a state where property taxes are paid in arrears is Illinois. Each county determines their schedule for property taxes. Cook County's taxes are due on June 1 (the first installment) and September 1 (the final payment.) But the taxes the Illinois homeowner pays on June 1 and September 1 are installments of the prior year's taxes. A homeowner who lived in Cook County in 2021 will pay for that privilege in 2022.

Not every state sets up their property taxes so that the property owners pay this year for last year's tax bill. Some states make property owners pay in advance. Michigan, for example, has a winter property tax and a summer property tax. Though it's easy to jump to the conclusion that each tax bill covers six months, this is not true. They each run a full year.

The winter tax amount covers the period December 1 through November 30 of the following year; the summer tax covers July 1 through June 30 of the following year. Both taxes must be paid in advance, on the first day of the tax year that they cover.

California does most things differently, including property taxes. In California, the tax year runs from July 1 through June 30. On the first day of the year, every property is the subject of a lien for property tax payable for the next tax year. The homeowner gets billed for the tax in two installments, the first due on November 10 (delinquent on December 10), and the second due on February 1 (delinquent on April 10.) Most people pay on or before the delinquent date since there is no penalty up to the date.

That means that the payment on December 10 covers the period from July 1 through December 31. It is largely a paid-in-arrears tax, paid after the period for which it is due. The April 10 payment covers the period from January 1 through June 30 of the following year. It is partially in arrears and partially in advance.

Property tax confusion increases when real estate is sold. That's because the property tax bill must be divided equitably between seller and buyer. Essentially, it is prorated between the two parties based on ownership periods.

Generally, proration works this way: The parties figure out exactly when ownership transfers. If the seller has paid the property tax for a period beyond that date, the buyer must reimburse them. If the seller has not yet paid tax for the period up to the closing date, they must do so.