8.3 Proration, Transfer Tax, and Investment Math

Proration, transfer tax, and investment math

These topics anchor the closing-statement and income-property questions. They reuse the value-rate-base logic but add timing and direction (credit vs. debit).

Proration basics

Proration divides a shared cost between buyer and seller based on who owned the property during the period. The steps are always the same:

1. Find the annual (or monthly) amount.
2. Divide to get the daily rate.
3. Count each party's days of ownership.
4. Multiply the daily rate by each party's days.

Exams use either a 360-day banker's year (12 months of 30 days) or a 365-day calendar year; the problem tells you which. Read carefully, because the daily rate differs.

Worked tax proration

Annual property tax is $3,650, paid in arrears, and closing is on day 100 of a 365-day year. The seller owned the property for the first 99 days (closing day usually charged to the buyer).

1. Daily rate = $3,650 / 365 = $10.00 per day.
2. Seller's share = 99 x $10.00 = $990.

Because taxes are paid in arrears (not yet paid), the seller owes their share. The $990 is a debit to the seller and a credit to the buyer, who will pay the full bill later.

Transfer / conveyance tax

Transfer tax is charged per increment of the sale price. If the rate is $0.50 per $500 of price on a $300,000 sale: $300,000 / $500 = 600 increments, and 600 x $0.50 = $300. If quoted per $1,000, divide the price by 1,000 instead. Always match the increment in the rate to your division.

A common variation rounds the price up to the next full increment before taxing. If a jurisdiction taxes $1.00 per $500 and the price is $300,250, round up to $300,500, giving 601 increments and $601 in tax. Read whether the problem rounds the price to a whole increment, because that single rule can shift the answer by one taxable unit.

Income-property math: NOI and cap rate

Investors value income property by its earnings. Start with effective gross income, then subtract operating expenses to reach net operating income (NOI). NOI excludes debt service (mortgage payments) and capital improvements.

• Potential Gross Income (all rent if fully leased)
• minus Vacancy and Collection Loss
• equals Effective Gross Income
• minus Operating Expenses (taxes, insurance, management, maintenance, utilities)
• equals Net Operating Income (NOI)

The capitalization rate ties NOI to value: Value = NOI / Cap Rate. Rearranged, Cap Rate = NOI / Value, and NOI = Value x Cap Rate. A property with $60,000 NOI at an 8% cap rate is worth $60,000 / 0.08 = $750,000. A higher cap rate signals higher risk and lower value for the same income.

Worked investment example

A 10-unit building rents for $1,200 per unit per month. Vacancy runs 5%, and operating expenses total $54,000 per year. The market cap rate is 9%.

1. Potential gross income = 10 x $1,200 x 12 = $144,000.
2. Vacancy loss = $144,000 x 0.05 = $7,200, so effective gross income = $136,800.
3. NOI = $136,800 - $54,000 = $82,800.
4. Value = $82,800 / 0.09 = $920,000.

Gross rent multiplier (GRM)

GRM is a quick screening tool: GRM = Sale Price / Gross Rent. If a property sold for $480,000 with $48,000 annual gross rent, the GRM is 10. To estimate value, multiply a comparable's gross rent by the market GRM. GRM uses gross rent (not NOI), so it ignores expenses and is less precise than cap-rate analysis. Some problems quote a monthly GRM using monthly rent rather than annual; check which the question uses, because a monthly GRM is roughly one-twelfth of the annual figure.

Cap rate moves value inversely

For a fixed income, raising the cap rate lowers value and lowering it raises value. Hold NOI at $90,000: at a 6% cap the value is $1,500,000, but at a 9% cap the value drops to $1,000,000. Investors demand higher cap rates on riskier properties, which is why an identical income stream sells for less in a weaker market. Expect a question that changes only the cap rate and asks for the new value.

Direction-of-entry trap

The single most missed closing-statement concept is direction. A prepaid expense (seller paid ahead) credits the seller; an accrued-but-unpaid expense credits the buyer. Compute the dollar amount first, then decide credit or debit second. Getting the number right but the direction wrong still loses the question.

California Transfer Tax and Special-Assessment Math

Closing math in California adds the documentary transfer tax and Mello-Roos special assessments, both common DRE calculation items.

Documentary Transfer Tax

California counties tax conveyances at $0.55 per $500 ($1.10 per $1,000) of value, figured net of any assumed loan. Worked example: a $725,000 sale with no assumed loan = $725,000 / $500 = 1,450 increments x $0.55 = $797.50. If a buyer assumes a $225,000 loan, tax is figured on the remaining $500,000 = $550. Many cities (San Francisco, Los Angeles, Oakland) add a separate city transfer tax that can dwarf the county tax, so a complete answer sums both where the problem gives a city rate.

A Worked Mello-Roos Add-On

Mello-Roos Community Facilities District assessments fund local infrastructure and are billed on top of the 1% Prop 13 tax. Suppose a home has a $640,000 assessed value (Prop 13 base tax $6,400) plus a fixed annual Mello-Roos levy of $1,800 and a $300 voter-approved bond. Total annual property-tax bill = $6,400 + $1,800 + $300 = $8,500, an effective rate of $8,500 / $640,000 = 1.33%. The exam uses this to show why effective California tax rates exceed the headline 1%.

A Worked Proration With the July Fiscal Year

California taxes run July 1 - June 30. A sale closes October 31 with a $7,200 unpaid annual tax. Monthly rate (360-day) = $7,200 / 12 = $600. Seller owned July, August, September, October = 4 months = 4 x $600 = $2,400, shown as a seller debit / buyer credit because the buyer will pay the full bill.

Trap: California's transfer tax is computed net of any assumed loan, and its property-tax year starts July 1. Using the gross price (ignoring an assumed loan) or a January 1 tax-year start are the two classic California closing-math errors.