1. Anywhere along the route, the brakes may be put on by the appraiser (and then the bank) who may not be willing to pass it through w/o proper C of O's (Certificates of Occupancy).
2. The bank may be okay with it, but your attorney may be looking out for your best interest and put a contingency on there being full C of O's on the property.
3. If you manage to purchase without the proper permits, when you go to sell it, the onus will be on you for the permits. If it is not legally done, it will have to be pulled out or reconstructed to code.
4. If you put a contingency on it that it have permits before closing, this will affect your taxes...they will go up.
Whatever decision you make is up to you and is fine, as long as you are prepared for the results of your actions.
People make improvements all the time without permits and have no problem. But when it comes right down to it, most of the time this is considered BREAKING THE LAW. It could be considered Tax Evasion, fraud or who knows what else. For example, if you knowingly buy stolen merchandise than you are an accessory to the crime. I'm not an attorney, govt official or even a real estate agent. I'm just answering your question as a possible (although unlikely) risk.
So my question to you, Michele, is what are your plans if you buy the home? Are you buying it to fix it up? Are you buying it move-in condition? Is it priced based on this bathroom counting or not counting? Do you need this bathroom? Gail also brings up a very good point about the taxes increasing based on an improvement made to the home. Would an increase in taxes be a strain on your budget?
I'm not saying you should not buy this house, this could be your best opportunity for renegotiating and getting a great deal. You've already taken the best first step by getting brainstorming answers of possible risks that you, your agent or your attorney may not have considered. Good luck with your continued investigation.
Oh, in searching for a good link it brought up an issue I had to deal with. I call it opening a can of worms. An inspector has the right to make you upgrade more than just the bathroom to CURRENT building codes. If you don't make improvements, existing conditions are usually "grandfathered" in as long as it met code when the improvement was originally made. For example, code today (and for years) requires that bathrooms have GFCI electric outlets. So that means you need an electrical permit which then opens the can of worms to your entire house possibly needing ALL the electrical work upgraded to current 2008 local and international code. I've bought several old homes (pre-1930s) and they have had cloth covered wires which today is considered a fire hazard. Everywhere I have lived (in Illinois) at that time, you could buy and live in a home with this wiring and 60 AMP fuse panel as long as you didn't touch any of the electric. Once you make an improvement, all the wiring may have to be replaced. In some towns, however, that is now changing and a sale must meet some minimum safety requirements such as circuit breakers instead of fuses.
So I would absolutely talk to the building department before preceding.
What you should do is go to a building department in the city and ask a building inspector how one would go about this situation. Since it is already built they will likely be willing to legalize it as long as it was built in compliance with building code.
So, either ask sellers to do it themselves (can be a contingency in your purchase and sale agreement that they need to do that before closing) or get them to make an appointment and come in with the building inspector, see if he feels it was built correctly and what possible issues might come up if you try to legalize it.