How to Calculate Proration for the Real Estate License Exam
Real Estate License Exam writers expect you to know the basics of proration math. Proration is the allocation or dividing of certain money items at the closing. An attorney, a real estate salesperson, or a broker does the proration calculations at the closing. The key to remember about prorations is that the person who uses it needs to pay for it. Here’s an example that illustrates the point of proration.
The seller has paid taxes of $3,000 for the entire year ahead on January 1 and sells his property and closes title on June 1. Who owes what to whom?
The seller paid the full year’s taxes, but used the property only for the five months (January through May). Read the problem carefully. The buyer needs to pay the seller for the taxes already paid for the months the seller won’t own the property during the year. The rest is just the math of dividing up who paid and who pays.
$3,000 ÷12 months = $250 per month
$250 per month x 5 months (the time the seller owned the property) = $1,250
This is the amount of the taxes that the seller used from January through May.
$250 per month x 7 months (the new buyer’s time in the house) = $1,750
This is the amount of the taxes the buyer used, because he bought the house on June 1.
Because the seller had already paid the taxes for the whole year, the buyer owes the seller $1,750 for the taxes the buyer is using but didn’t pay for. In the terminology of proration, the buyer gets a debit and the seller gets a credit.
Here’s another problem that has the buyer paying in arrears (or after the fact).
A buyer pays $2,400 in taxes in arrears for the entire year on December 31. He bought the house on September 1. Who owes what to whom?
$2,400 ÷12 months = $200 per month
$200 per month x 8 months (the time the seller owned the house) = $1,600
The seller used $1,600 of the paid taxes. Now to determine how much the seller didn’t use:
$200 per month x 4 months (the time the buyer owned the property) = $800
Because the buyer paid the full $2,400 for the previous year, during which he owned the house for only four months, the seller owes the buyer $1,600. The buyer gets a credit and the seller gets a debit.
When you get out into the real world, find out what the local practice is for dividing up the year for prorations. Some areas and attorneys use the exact day, rather than the month. So in the previous examples, divide by 365 days to get the amount of taxes paid per day.
Some people use the 12-month annual calculation and then divide by the exact number of days in a month when the closing dates occurs midmonth. On the exam, test writers usually specify actual days if they want you to calculate it that way.
If the time frame isn’t specified or you’re instructed otherwise on an exam, you need to use the third method, which is to divide a yearly cost or payment by 12 and the monthly number by 30, unless your real estate course or textbook specifies that one of the other methods is the only method used in your state.
The other state-specific item that can affect proration is who owns the property on the day of closing. Unless your state says otherwise, assume that the buyer owns the house on the closing date. Here is a problem with a mid-month closing date to illustrate the 12-month/ 30-day method.
An owner sells a house, closes on May 17, but paid a full year’s taxes of $3,600 in advance on January 1. What is the proration of taxes?
$3600 ÷12 months = $300 per month
$300 ÷30 days = $10 per day
The seller/owner owned the house for four full months (January through April) and 16 days in May. (Remember, the buyer is considered to own the house on the day of closing.)
4 months x $300 per month = $1,200
16 days x $10 per day = $160
$1200 + $160 = $1,360 taxes used by the seller
$3,600 (total taxes for the year paid by the seller) – $1,360 (taxes used by the seller) = $2,240 (taxes used by the buyer)
The buyer owes the seller $2,240. The buyer gets a debit of $2,240, and the seller gets a credit of $2,240.