How are annual expenses such as property taxes and homeowner insurance prorated between buyer and seller at closing?
Prorations allocate annual expenses between buyer and seller based on the number of days each party owns or is responsible for the property. The daily rate is calculated by dividing the annual expense by 365 days (or 360 in some cases). The buyer is typically charged for the closing date forward; the seller is credited for their period.
Key Takeaways
- Prorations allocate annual expenses between buyer and seller based on the number of days each party owns or is responsible for the property.
- The daily rate is calculated by dividing the annual expense by 365 days (or 360 in some cases).
- The buyer is typically charged for the closing date forward; the seller is credited for their period.
Transfer of Property on the Real Estate Exam
Prorations ensure fairness by allocating annual costs proportionally based on actual ownership periods. Property tax prorations are heavily tested because they involve precise calculations. Understanding both the mechanics and the fairness principle helps agents explain closing costs accurately to clients.
Understanding Transfer of Property: Key Concepts
What It Means
Prorations divide annual expenses so that each party pays only for the period they own or are responsible for the property. Common items subject to proration include property taxes, homeowner association dues, property insurance, rental income (in investment properties), and utilities prepaid by the seller. The key principle is that the buyer takes the property as of the closing date, so prorations determine responsibility from that point forward.
The most common proration method uses a daily rate. For a $3,650 annual property tax bill, the daily rate is $3,650 divided by 365 days, which equals $10 per day. If closing occurs on June 15, the seller is responsible for January 1 through June 14 (165 days), and the buyer is responsible for June 15 through December 31 (200 days). The seller would receive a $1,650 credit (165 days times $10), and the buyer would be charged $2,000 (200 days times $10).
Some jurisdictions use a 360-day method (12 months of 30 days each) instead of 365 days. This method is less common but may be required by contract or local custom. The 360-day method typically results in slightly different daily rates. The contract usually specifies which method applies, but agents should clarify this with the closing agent to avoid surprises.
Prorations appear on the settlement statement as debits and credits. A debit to the buyer means the buyer will pay that amount at closing; a credit to the buyer means the buyer receives a reduction in the net amount due. The settlement statement shows all prorations clearly so parties understand how closing costs are calculated. Some expenses are paid by one party or the other; for example, the seller typically pays transfer taxes, while the buyer pays for the lender's title policy.