8.3 Proration, Transfer Tax, and Investment Math

Proration basics

Proration splits a shared expense — property taxes, HOA dues, prepaid insurance — fairly between buyer and seller based on who owns the property on each day. The exam default is a 360-day year with 30-day months (banker's year) unless the problem says "actual days."

Steps: (1) find the daily rate, (2) count the days each party owns, (3) charge/credit accordingly. Items the seller used but did not pay are accrued (seller debit, buyer credit); items the seller prepaid are credited back to the seller.

Worked tax proration

Annual taxes are $3,600, unpaid, and closing is on April 30. Using a 360-day year, the daily rate = $3,600 ÷ 360 = $10/day. The seller owned the property January 1 through April 30 = 4 months × 30 = 120 days.

Seller's share = 120 × $10 = $1,200. Because the taxes are unpaid (accrued), the seller is debited $1,200 and the buyer is credited $1,200, since the buyer will pay the full bill later.

Trap: a prepaid expense reverses direction — the seller gets a credit for the unused portion.

Equity, loan balance, and a net-to-seller worked example

Equity = market value − liens. A home worth $420,000 with a $260,000 mortgage balance has $160,000 equity. Sellers care about net proceeds, which the exam builds as: sale price − payoff − commission − seller-paid closing costs.

Worked net-to-seller: sale price $420,000, mortgage payoff $260,000, commission 6% ($25,200), and $4,800 in seller costs. Net = $420,000 − $260,000 − $25,200 − $4,800 = $130,000. The reverse question — "what price nets the seller $X after a 6% commission?" — is solved by dividing the required gross by (1 − 0.06), because the commission rides on the unknown sale price, not on the net.

Cash-on-cash return and depreciation for investors

Investors judge a deal by cash-on-cash return = annual pre-tax cash flow ÷ cash invested. If a buyer puts $120,000 down and the property throws off $12,000 of cash flow after debt service, the return is $12,000 ÷ $120,000 = 10%.

For tax purposes, only improvements depreciate, not land, and residential rental uses a 27.5-year straight-line recovery while commercial uses 39 years. A $330,000 building (land excluded) depreciates at $330,000 ÷ 27.5 = $12,000/year. The exam trap mirrors the appraisal rule: strip out land before computing depreciation, and remember that depreciation is a paper deduction that does not reduce actual cash flow.

Rent proration and a combined-credit closing scenario

Income-property closings prorate rent already collected as well as taxes. Suppose the seller collected $3,000 of June rent and closing is June 20 on a 30-day month. The buyer owns the property for the last 10 days, so the buyer is owed 10/30 x $3,000 = $1,000. Because the seller holds cash the buyer is entitled to, the seller is debited $1,000 and the buyer is credited $1,000 — the reverse direction from an unpaid tax bill.

Stacking adjustments builds the exam's hardest items: a single statement may credit the buyer for accrued unpaid taxes and for prepaid rent while debiting the buyer for prepaid insurance the seller already paid. Work each item separately, decide its direction (accrued vs. prepaid), then total the column. The recurring rule: whoever holds money that belongs to the other party is debited, and the other party is credited.

Operating statements: from GSI to NOI to value

Income-approach items often hand you a small operating statement and ask for value. Start with gross scheduled income (GSI), subtract a vacancy and collection loss to get effective gross income (EGI), then subtract operating expenses (taxes, insurance, management, repairs — never mortgage payments) to reach net operating income (NOI).

Worked build-up: GSI $80,000; vacancy 5% (−$4,000) gives EGI $76,000; operating expenses $28,000 leaves NOI $48,000. At an 8% cap rate the value is $48,000 ÷ 0.08 = $600,000. The two traps: candidates wrongly subtract the mortgage payment (debt service is excluded from NOI), or they forget the vacancy deduction. Keep the order GSI → EGI → NOI fixed, and cap only the NOI to value the property.

Transfer and recording tax

Transfer (conveyance) tax is charged per unit of sale price — often per $500 or per $1,000. Formula: Tax = (Price ÷ Unit) × Rate per unit.

Example: a state charges $0.50 per $500 of price on a $300,000 sale. Units = $300,000 ÷ $500 = 600 units. Tax = 600 × $0.50 = $150.

If the rate is given per $1,000 (e.g., $1.10 per $1,000), use 300 units instead. Read the unit carefully — mixing $500 and $1,000 units doubles or halves the answer, a favorite distractor.

Investment: capitalization rate

Income property is valued by the income approach using a cap rate.

• Value = NOI ÷ Cap Rate
• Cap Rate = NOI ÷ Value
• NOI = Value × Cap Rate

Net operating income (NOI) is effective gross income minus operating expenses — before debt service. A property with $48,000 NOI at an 8% cap rate is worth $48,000 ÷ 0.08 = $600,000. Higher cap rates produce lower values, reflecting greater risk.

Gross rent multiplier and profit

The gross rent multiplier (GRM) is a quick screen: GRM = Price ÷ Gross (Monthly or Annual) Rent. A $240,000 property renting for $2,000/month has a monthly GRM of 120.

Profit/loss percentage = Amount of gain or loss ÷ Original cost. If a home bought for $250,000 sells for $290,000, the gain is $40,000, and percent profit = $40,000 ÷ $250,000 = 16%. Always divide by the original basis, not the new sale price — that is the most common percentage trap on the exam.