8.3 Proration, Transfer Tax, and Investment Math
Key Takeaways
- Proration divides shared costs at closing between buyer and seller by days of ownership.
- Items paid in arrears (property taxes) are usually owed by the seller through the closing date.
- Transfer tax is computed on the sale price, often per a stated dollar increment.
- Profit/loss percentage uses the original cost as the base, not the sale price.
- Cost recovery (depreciation) applies only to the improvement value, not the land.
Proration at closing
Proration splits a shared annual cost between buyer and seller based on who owned the property during the period. The exam usually uses a 360-day banker's year (30 days per month) unless it says to use actual days.
Steps for a tax proration
- Find the annual amount.
- Divide by 360 to get a daily rate (or by 12 for a monthly rate).
- Multiply the daily rate by the number of days the responsible party owned the property.
Property taxes are typically paid in arrears, so the seller owes taxes from January 1 through the closing date and credits the buyer that amount.
Watch the closing-date convention. Some exams charge the seller through the day before closing; others include the day of closing as the seller's. The question will tell you which to use, and the difference is exactly one daily rate, so read carefully. When in doubt and the exam is silent, the common default is that the seller pays through the day of closing.
A worked proration
Annual taxes are $3,600 and closing is on April 30, with the seller responsible through the day of closing. Using a 360-day year:
- Daily rate: 3,600 / 360 = $10 per day.
- Seller's days: January through April = 4 months x 30 = 120 days.
- Seller's share: 120 x $10 = $1,200 credited to the buyer at closing.
The buyer is then responsible for the remaining $2,400 when the bill comes due. If taxes were prepaid, the direction flips: the buyer would reimburse the seller for the unused portion.
Transfer (conveyance) tax
Transfer tax is charged on the sale price, frequently quoted per increment (for example, $0.50 per $500). Convert the price into the number of increments, then multiply.
Example: a $300,000 sale taxed at $1.00 per $1,000 of price. Increments = 300,000 / 1,000 = 300. Tax = 300 x $1.00 = $300. The base is always the price, not equity or loan amount.
A second example with a half-dollar increment: a $250,000 sale taxed at $0.50 per $500. Increments = 250,000 / 500 = 500. Tax = 500 x $0.50 = $250. Round the number of increments up if the price does not divide evenly and the rule says taxable value is rounded to the next increment, a detail some jurisdictions add. The arithmetic pattern stays the same: divide the price by the increment, then multiply by the rate per increment.
Investment and profit math
Percentage profit or loss uses the original cost as the base. Profit % = (sale price - cost) / cost.
An investor buys for $200,000 and sells for $260,000: profit = 60,000 / 200,000 = 30%. Dividing by the sale price instead gives a wrong 23%, the most common error.
To find a sale price that yields a target profit, multiply cost by (1 + profit rate). For a 25% profit on a $200,000 cost: 200,000 x 1.25 = $250,000.
Straight-line depreciation (cost recovery)
Depreciation applies only to the improvement (building) value, never to land. Annual cost recovery = improvement value / useful life.
| Item | Figure |
|---|---|
| Total purchase price | $500,000 |
| Land value (not depreciable) | $100,000 |
| Improvement value | $400,000 |
| Useful life | 40 years |
| Annual depreciation | 400,000 / 40 = $10,000 |
After 5 years, total depreciation is 5 x $10,000 = $50,000, and the adjusted basis of the improvement is $350,000. Land stays at $100,000.
Prepaid items and who owes whom
Proration direction depends on whether an item was paid in arrears or in advance. Taxes paid in arrears mean the seller used the service but has not paid, so the seller credits (pays) the buyer. Items paid in advance — such as an annual HOA assessment, insurance the buyer assumes, or prepaid water — mean the seller already paid for time the buyer will enjoy, so the buyer reimburses the seller.
| Item | Typically paid | Who owes whom at closing |
|---|---|---|
| Property taxes | In arrears | Seller credits buyer |
| HOA dues paid yearly | In advance | Buyer reimburses seller |
| Rent collected by seller | In advance | Seller credits buyer for unused days |
| Interest on assumed loan | In arrears | Seller credits buyer |
For collected rent, the seller has the buyer's portion in hand, so the seller credits the buyer the days after closing.
Equity, gross rent multiplier, and cash flow
Two more investment tools appear regularly. Equity is value minus what is owed: a $400,000 property with a $260,000 loan balance has $140,000 of equity. Gross rent multiplier (GRM) = price / gross annual (or monthly) rent. A $300,000 property renting for $2,500 a month has a monthly GRM of 300,000 / 2,500 = 120. To value a comparable renting for $2,800, multiply 2,800 x 120 = $336,000.
Cash flow is NOI minus annual debt service. If NOI is $48,000 and annual loan payments total $36,000, cash flow before taxes is $12,000. Notice debt service returns here even though it was excluded from NOI — NOI measures the property, cash flow measures the investor's pocket. Keep those two ideas separate and you will sort most investment questions correctly.
One more return metric closes the loop: cash-on-cash return divides annual cash flow by the cash actually invested. If the investor put $120,000 down and earns $12,000 of cash flow, the cash-on-cash return is 12,000 / 120,000 = 10%. Do not confuse this with the cap rate, which divides NOI by total value and ignores financing entirely. The cap rate describes the property's unleveraged yield; cash-on-cash describes the leveraged investor's yield. Reading which return the question wants — cap rate, cash-on-cash, or simple profit percentage — points you to the correct numerator and denominator before you compute.
Annual property taxes of $4,320 are paid in arrears. Closing is June 30 and the seller is responsible through the closing date. Using a 360-day year, what amount is credited to the buyer?
An investor purchased a property for $180,000 and later sold it for $216,000. What was the percentage profit?