9.3 Closing Prorations: 360-Day Banker's Year vs. 365-Day Actual Year

Purpose & Accounting Mechanics of Closing Prorations

Proration is the process of dividing ongoing property expenses and revenues between the buyer and seller so that each party is financially responsible only for the period during which they hold equitable or legal title.

The Double-Entry Settlement Framework

Closing disclosures and settlement statements operate on a double-entry ledger system:

• Debit: An expense, charge, or obligation owed by a party (reduces net cash proceeds to seller; increases cash required from buyer).
• Credit: An asset, reimbursement, or payment receivable by a party (increases net cash proceeds to seller; reduces cash required from buyer).

┌────────────────────────────────────────────────────────────────────────┐
│                        PRORATION LEDGER DYNAMICS                       │
├────────────────────────────────────┬───────────────────────────────────┤
│ PAID IN ADVANCE (by Seller)        │ PAID IN ARREARS (by Buyer later)  │
├────────────────────────────────────┼───────────────────────────────────┤
│ • Fuel oil in tank                 │ • Accrued real estate taxes       │
│ • Prepaid municipal taxes          │ • Unpaid utility charges          │
│ • Prepaid HOA fees                 │ • Accrued mortgage interest       │
│                                    │                                   │
│ ➔ CREDIT SELLER / DEBIT BUYER      │ ➔ CREDIT BUYER / DEBIT SELLER     │
└────────────────────────────────────┴───────────────────────────────────┘

Closing Day Ownership Convention

When calculating prorations, the division of ownership on the closing day itself dictates the day count:

1. Standard Exam Convention (Seller Owns Through Midnight Before Closing): The seller is financially responsible for all expenses through the day prior to closing; the buyer owns the property on closing day and is responsible for all closing day costs.
2. Alternative Convention (Seller Owns Through the Day of Closing): The seller is charged through and including the closing day; the buyer's financial responsibility begins the day after closing.

Unless an exam problem explicitly specifies that 'the seller owns the day of closing,' standard exam protocol designates the buyer as owning the day of closing (seller responsible through the preceding day). Always inspect question text for specific instructions.

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360-Day Banker's Year vs. 365-Day Actual Year Methods

Two distinct computational methodologies appear on real estate licensing examinations:

1. The 360-Day Banker's Year (Statutory Year)

The 360-day banker's year assumes an artificial calendar of 12 months, each having exactly 30 days ($12 \times 30 = 360\text{ days}$).

$\text{Monthly Rate} = \frac{\text{Annual Amount}}{12}$

$\text{Daily Rate} = \frac{\text{Annual Amount}}{360} = \frac{\text{Monthly Rate}}{30}$

• Computational Procedure:
  1. Calculate full elapsed or remaining months and multiply by the monthly rate.
  2. Count extra days in the partial month and multiply by the daily rate.
  3. Sum the full-month and partial-month figures.

2. The 365-Day Actual Year (Calendar Year)

The 365-day method uses the exact number of calendar days in each specific month (31, 28/29, 31, 30, etc.) and divides by 365 (or 366 in leap years):

$\text{Daily Rate} = \frac{\text{Annual Amount}}{365}$

• Computational Procedure:
  1. Count the exact number of days from the start of the period to the cutoff date.
  2. Multiply exact days by the daily rate.

Side-by-Side Methodology Comparison

• Problem: Annual real estate taxes are $7,200. Taxes have been paid in full for the calendar year by the seller. Closing takes place on April 16. The seller owns the property through midnight on April 15 (buyer owns the day of closing). Calculate the credit to the seller using both methods.

┌──────────────────────────────────────┬──────────────────────────────────────┐
│     360-DAY BANKER'S YEAR METHOD     │      365-DAY ACTUAL YEAR METHOD      │
├──────────────────────────────────────┼──────────────────────────────────────┤
│ Monthly Rate = $7,200 / 12 = $600    │ Daily Rate = $7,200 / 365 = $19.7260 │
│ Daily Rate = $600 / 30 = $20.00      │                                      │
│                                      │ Seller Elapsed Days:                 │
│ Seller Period (Jan 1 - Apr 15):      │ • Jan: 31 days                       │
│ • 3 full months (Jan, Feb, Mar)      │ • Feb: 28 days                       │
│ • 15 days in April                   │ • Mar: 31 days                       │
│ Seller Cost = (3 x $600) +           │ • Apr: 15 days                       │
│               (15 x $20) = $2,100    │ Total Elapsed Days = 105 days        │
│                                      │ Seller Cost = 105 x $19.7260         │
│ Buyer Period (Apr 16 - Dec 30):      │             = $2,071.23              │
│ • 15 days in April = $300            │                                      │
│ • 8 full months (May - Dec) = $4,800 │ Buyer Unused Days = 365 - 105        │
│ Buyer Reimbursement = $5,100         │                   = 260 days         │
│                                      │ Buyer Reimbursement = 260 x $19.7260 │
│ Accounting Entry:                    │                     = $5,128.76      │
│ Credit Seller: $5,100.00             │ Accounting Entry:                    │
│ Debit Buyer:   $5,100.00             │ Credit Seller: $5,128.76             │
│                                      │ Debit Buyer:   $5,128.76             │
└──────────────────────────────────────┴──────────────────────────────────────┘

Notice the $28.76 variance resulting from the statutory 30-day month simplification versus actual calendar month lengths.

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New Jersey Quarterly Municipal Property Tax Prorations

In New Jersey, real estate taxes are levied by municipalities on a calendar-year basis but billed and payable in four distinct quarters:

• Quarter 1: January 1 – March 31 (Due February 1)
• Quarter 2: April 1 – June 30 (Due May 1)
• Quarter 3: July 1 – September 30 (Due August 1)
• Quarter 4: October 1 – December 31 (Due November 1)

Quarterly Proration Example

• Scenario: A home in Montclair closes on August 20. The annual tax bill is $14,400. Third quarter taxes ($3,600) were paid in full by the seller on August 1. Using the 360-day banker's year method and assuming the seller owns through the day of closing (seller pays closing day), calculate the tax proration.

1. Quarter 3 Parameters:

   • Period: July 1 through September 30 (90 statutory days: 30 days July + 30 days August + 30 days September)
   • Quarterly Tax: $$14,400 / 4 = $3,600$
   • Daily Tax Rate: $$3,600 / 90\text{ days} = $40.00/\text{day}$

2. Seller's Share of Quarter 3 (July 1 through August 20):

   • July: 30 days
   • August: 20 days (seller owns day of closing)
   • Total Seller Days: $30 + 20 = 50\text{ days}$
   • Seller Tax Obligation: $50\text{ days} \times $40.00 = $2,000$

3. Buyer's Share of Quarter 3 (August 21 through September 30):

   • August: $30 - 20 = 10\text{ days}$
   • September: 30 days
   • Total Buyer Days: $10 + 30 = 40\text{ days}$
   • Buyer Tax Obligation: $40\text{ days} \times $40.00 = $1,600$

4. Settlement Accounting Entry:

   • The seller prepaid the entire $3,600 quarter. The buyer must reimburse the seller for the 40 days the buyer will occupy the property:
   • Credit Seller: $1,600.00
   • Debit Buyer: $1,600.00

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Rent Prorations & Security Deposit Legal Transfer

When income-producing residential or commercial real estate is sold, leases survive the transfer of title under New Jersey law.

Rent Proration Rules

Rent is typically collected on the first day of the month for the upcoming monthly rental period. Because the seller collected rent for days they will not own the property, the unearned portion belongs to the buyer:

$\text{Daily Rent} = \frac{\text{Monthly Rent}}{\text{Days in Month}}$

$\text{Unearned Rent to Buyer} = \text{Daily Rent} \times \text{Buyer's Days in Month}$

• Accounting Entry: Debit Seller / Credit Buyer

Transfer of Security Deposits (N.J.S.A. 46:8-19 et seq.)

[!CAUTION] Critical Exam Rule on Security Deposits: Tenant security deposits are NEVER prorated! Under the New Jersey Security Deposit Law (N.J.S.A. 46:8-19 et seq.), tenant security deposits remain the property of the tenant held in trust by the landlord. Upon closing, the seller must transfer 100% of all tenant security deposits—along with any accrued statutory interest—directly to the buyer.

• Settlement Entry for Security Deposits:
  • Debit Seller 100% of Deposit Amount
  • Credit Buyer 100% of Deposit Amount
  • The seller must provide written notice to the tenants by registered or certified mail within 30 days of closing, disclosing the name and address of the new landlord/depository institution where deposits are held.

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Mortgage Interest Proration on Payoffs vs. Assumptions

Loan Payoff Proration

Mortgage interest is almost universally paid in arrears. For example, a mortgage payment made on May 1 covers accrued interest for the month of April.

When a seller pays off a mortgage at closing, they owe accrued interest from the date of the last paid installment through the exact payoff date:

$\text{Daily Interest} = \frac{\text{Principal Balance} \times \text{Annual Rate}}{360\text{ (or 365)}}$

• Example: Seller's loan balance is $240,000 at 5.5% interest. The last payment was made on October 1 (covering interest through September 30). Closing takes place October 18, and payoff funds arrive at the lender on October 18. Seller pays 18 days of accrued October interest at settlement:

$\text{Daily Interest} = \frac{\$240,000 \times 0.055}{360} = \frac{\$13,200}{360} = \$36.67/\text{day}$

$\text{Accrued Interest Owed} = 18\text{ days} \times \$36.67 = \$660.06$

• Settlement Entry: Debit Seller $660.06 (added to loan payoff demand).