Prorations in Real Estate

Doing Proration Math

Figuring the prorated tax for the buyers and sellers is a five-part process:

Calculate the daily tax rate by dividing the annual tax rate by the days in the year (365, or 366 for leap years). Look up the day count for the closing date. For example, the day counts for Jan. 1 and Dec. 31 are 1 and 365 respectively (for a non-leap-year). Calculate the sellers’ number of days as the closing day count minus 1. Calculate the buyers’ number of days as the days in the year minus the sellers’ number of days. Calculate each party’s tax obligation as their number of days times the daily tax rate times the property’s assessed value.

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Seller’s Previous Payments

If the sellers have already paid more tax than they owe, they are due a refund at closing. The closing agent will transfer the refund amount from the buyer’s escrow account, which has money set aside for the refund and the next tax payment. If the sellers have not paid the full amount of property tax they owe, the amount due gets deducted from their escrow account, via a check written by the seller, or deducted from the sale proceeds paid to the seller. The buyers pay their share from their escrow account. The closing agent collects all the real estate tax money and deposits it with the tax authority.

How can this be solved?

Typically, the owner of the building will take the annual expenses for each of the common areas and divide it by the amount of rental-eligible square footage in the building. She will then prorate these expenses to each renter based on the amount of space they are renting.

Whether you are a landlord or tenant, you can use this proration formula to ensure things are financially fair.

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Bills

Sometimes utility bills like water, gas, and electricity will be prorated during the sale of a home. While this situation is slightly less common than prorating taxes, it could come up at closing, so you should be ready to discuss it with your representation.

For example, if the seller of a home doesn't pay the county or city utilities, then the bills will roll over to tax assessments. They will then be deducted from the tax bill for proration and the person purchasing the home will receive a credit for future tax bills.

Typically, this happens during a short sale or a bank foreclosure because if the person selling the house hasn't been paying his mortgage, then he is likely not paying his other bills either.

Between Bank and Seller

Depending upon the terms of the loan, several items might be prorated and paid to the bank. For example, the bank prorates interest to the start of the loan. When property is sold, the first mortgage payment is typically due the first day of the second month following the sale. In the case of an April sale, the first payment would be due June 1. The amount of interest in that payment is for the previous month — in this case, the month of May. But in this example, the owner had the loan since April 20. At closing, the bank will prorate the interest expense for the balance of the month of April, to be paid by the buyer.

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