8.3 Proration, Transfer Tax, and Investment Math
Key Takeaways
- Proration uses a 360-day statutory year or a 365-day calendar year; the exam states which to apply.
- A prepaid expense credits the seller and debits the buyer; an unpaid (arrears) expense reverses that.
- Transfer tax is charged per stated increment of sale price ($/100 or $/500); match the increment exactly.
- Value = NOI / Cap Rate, and NOI excludes debt service, depreciation, and income tax.
- GRM = Price / Gross Rent; a lower cap rate or higher GRM signals a higher price relative to income.
Proration at Closing
Proration divides a shared expense (property taxes, rent, HOA dues, insurance) between buyer and seller based on who owns the property each day. The seller pays through the day of closing in most exam conventions; the buyer owns from the day after. The two methods you must know:
- Statutory (banker's) year: 360 days, 30 days per month. Simpler arithmetic, common on exams.
- Calendar (actual) year: 365 days using the real days in each month. More precise.
The exam will tell you which to use, or default to the 360-day method when it says "per the statutory year."
Worked Proration Example
Annual property tax is $3,600, already paid by the seller for the full year, and closing is June 30 using a 360-day year. The seller owns Jan 1 through June 30 (6 months = 180 days); the buyer owns the remaining 180 days.
Daily rate = $3,600 / 360 = $10/day. Buyer's share (the credit owed to the seller, since the seller prepaid) = 180 x $10 = $1,800.
The seller is credited and the buyer is debited $1,800 because the seller already paid taxes covering the buyer's ownership period. If instead the taxes were unpaid, the seller would be debited for the days they owned and the buyer credited the same amount. To compute a partial month under the 365-day method, find a daily rate from the annual amount divided by 365, then count the exact calendar days. The arithmetic is identical; only the divisor and the day-count change. Always state the closing-day convention before you begin counting days.
Debits and Credits Logic
Direction matters more than the dollar amount on closing-statement questions:
| Situation | Seller | Buyer |
|---|---|---|
| Seller prepaid an expense | Credit | Debit |
| Expense unpaid (arrears) | Debit | Credit |
| Rent collected in advance for buyer's days | Debit | Credit |
Think: whoever benefits from money already spent owes it back; whoever will pay a bill covering the other party's days is owed reimbursement.
Rent Proration Example
A seller collected $2,400 of monthly rent on the first of the month, and closing falls on the 16th using a 30-day month. The seller is entitled to days 1 through 16 (16 days) and the buyer to the remaining 14 days. Daily rent = $2,400 / 30 = $80. Buyer's share = 14 x $80 = $1,120. Because the seller already collected this prepaid rent that belongs to the buyer's ownership days, the seller is debited $1,120 and the buyer credited $1,120. Prepaid income flips the direction compared with a prepaid expense, a point examiners test deliberately.
Transfer Tax and Recording Fees
Transfer (conveyance) taxes are charged on the sale price, usually quoted per $500 or per $100 of value, or as a flat percentage. Read the increment carefully.
Example: a state charges $1.50 per $500 of sale price on a $425,000 sale. Number of $500 increments = 425,000 / 500 = 850. Transfer tax = 850 x $1.50 = $1,275. If the question rounds up to the next full increment, round the number of $500 units up before multiplying.
A flat 0.5% rate would give the same answer as $2.50 per $500, so always match the stated increment rather than assuming a percentage. Recording fees, by contrast, are usually flat per-document charges and do not scale with sale price, so never apply a percentage to them. Examiners mix transfer tax (price-based) and recording fees (flat) in the same closing scenario precisely to see whether you treat each correctly.
Investment Math
Income property is valued and analyzed with a few core formulas:
- Net Operating Income (NOI) = Effective Gross Income - Operating Expenses (NOT including debt service or income tax)
- Capitalization Rate = NOI / Value
- Value = NOI / Cap Rate
- Cash-on-Cash Return = Annual Pre-Tax Cash Flow / Cash Invested
- Gross Rent Multiplier (GRM) = Price / Gross Annual (or Monthly) Rent
The IRV triangle (Income, Rate, Value) mirrors the Total-Part-Rate device: cover the unknown to see whether to multiply or divide.
Worked Investment Example
An apartment building produces $96,000 in NOI and comparable sales suggest an 8% cap rate. Value = NOI / Cap Rate = $96,000 / 0.08 = $1,200,000. A GRM problem: a fourplex sells for $720,000 and generates $90,000 in gross annual rent. GRM = 720,000 / 90,000 = 8.0. A lower cap rate signals a higher price and lower perceived risk; a higher GRM means you are paying more per dollar of rent.
Cash-on-Cash Return
Where cap rate ignores financing, cash-on-cash return rewards leverage by measuring the actual cash an investor recovers. An investor puts $300,000 down and, after debt service, nets $24,000 in annual pre-tax cash flow. Cash-on-cash = $24,000 / $300,000 = 8%. Note that debt service and depreciation never enter NOI but DO enter cash flow, so the same property can show one figure for cap rate and a different one for cash-on-cash. Keeping the two formulas distinct is the single most common income-property trap on the exam.
Annual property taxes of $4,800 are unpaid at a June 30 closing using a 360-day statutory year. What appears on the seller's closing statement for taxes?
A commercial property has effective gross income of $150,000, operating expenses of $60,000, and annual debt service of $40,000. Using a 9% cap rate, what is its value?
Trap Checklist
Confirm whether the year is 360 or 365 days; decide debit vs. credit by who already paid or will pay; multiply transfer tax by the stated increment ($/100 or $/500), rounding units up when instructed; and keep debt service and income tax out of NOI. The IRV triangle turns most income questions into a single multiply-or-divide step.