Real Estate Tax Law
Real estate tax law is a discussion of both the tax imposed on real estate and the tax implications that are triggered when real estate is sold. The rules are based on a combination of federal and Illinois law.
Property taxes. Illinois counties are divided into property tax districts. Each district assesses a property tax on real estate located within the district. The tax is generally computed by multiplying the property's assessed value by the tax rate (in Cook County, it is also multiplied by what is called an equalization factor). Real estate tax revenues are a critical part of the local funding for public schools, parks, and other facilities.
Each parcel of property is reappraised roughly every three years. Taxpayers can apply for a reduction in the assessed value or challenge the valuation. A taxpayer might want to challenge the value where, for example, a property's valuation is significantly above similar properties in the same area. Appeals are filed with the tax assessor's office.
Property taxes are billed and paid twice a year. Taxes not paid by the due date are considered delinquent. The taxing body will notify the owner of the delinquency and give him or her the opportunity to pay the overdue taxes, plus interest and penalties. If the taxes are not paid, the property can be sold to pay off the back taxes. Even after the property is sold, the former owner has an opportunity to redeem the property by paying taxes, interest, and penalties.
Property transactions. When real estate is sold, there are, of course, tax consequences. The taxes that might be owed include capital gains tax, income tax, depreciation recapture tax, and state or local taxes.
Capital gains tax. The profit on the sale of real property held for more than one year is generally subject to a federal capital gains tax of 20% (property held for more than five years is subject to an 18% tax). To compute the amount owed, you start with your basis in the property, which is usually what you bought it for. You then adjust the basis by adding any improvements you made and subtracting depreciation or casualty losses. The adjusted basis is then subtracted from the purchase price to determine the amount that gets taxed. Slightly different rules may apply if you are receiving the purchase price over time rather than as a lump sum.
Income tax. Property held for less than a year is treated as ordinary income and is subject to state and federal income tax.
Recapture tax. If you used the property as business property and took a depreciation deduction on your tax returns, you now have to pay a recapture tax on the benefits you received from the depreciation deduction. The tax is 25% of the amount you deducted.
State and local taxes. State and local taxes imposed on a real estate transaction include transfer taxes and property registration taxes.
1031 exchanges. Under federal tax law, real estate owners who want to sell their property can avoid the capital gains tax by swapping their property for other property. Called 1031 exchanges because the applicable Internal Revenue Code section is 1031, these exchanges can involve any property used for business, trade, or investment purposes. The exchange does not have to be for the same type of property. Thus, investment property can be swapped for business property, and vice versa. The exchange rules also apply to personal property, although they're more restrictive than they are for real property.
The exchange does not have to occur simultaneously. Delayed exchanges are allowed, subject to rules requiring potential replacement properties to be identified within 45 days of the sale of your property. In any event, exchanged property must be purchased no later than 180 days after sale.