8.3 Proration, Transfer Tax, and Investment Math

Proration, Transfer Tax, and Investment Math

The final calculation cluster covers closing-statement math and income-property analysis. Prorations split shared expenses between buyer and seller at closing; transfer taxes are computed on the sale price; and investment math measures a property's return. These questions reward methodical setup over speed, because each has a defined sequence: find the daily or per-unit rate, then multiply by the correct count.

Proration fundamentals

Proration allocates a prepaid or accrued expense based on who owned the property on each day. The standard exam method:

1. Find the annual amount (taxes, insurance, rent).
2. Divide by 360 days (banker's year) or 365, as the question specifies, to get the daily rate.
3. Count the days each party is responsible for.
4. Multiply the daily rate by the day count.

The seller customarily pays through the day before closing (or the day of, per local custom). Read whether the expense is paid in advance (seller gets a credit) or in arrears (seller owes a debit). The two most common defaults on the national exam are a 360-day banker's year with 30-day months and a calendar-based 365-day year; the problem will tell you which to use, and switching methods mid-problem is a guaranteed wrong answer.

Worked proration example

Annual property taxes are 3,600 dollars, paid in arrears, closing June 30 on a 360-day year. Daily rate = 3,600 / 360 = 10 dollars per day. The seller owned the property January 1 through June 30 = 180 days. Seller's accrued share = 180 x 10 = 1,800 dollars.

Because arrears taxes are unpaid, the seller owes this amount: it is a debit to the seller and a credit to the buyer, who will pay the full bill later. Always state the direction (debit or credit) the question asks for.

Transfer tax and recording fees

Transfer tax is a percentage or per-unit charge on the sale price. A common format is a rate per 500 dollars of price. If the rate is 1.50 dollars per 500 dollars on a 240,000 dollar sale: 240,000 / 500 = 480 units; 480 x 1.50 = 720 dollars.

If the question gives a flat percentage instead, multiply directly: a 0.5 percent transfer tax on 240,000 dollars = 1,200 dollars. Watch whether the tax rounds up to the next whole unit, a detail some jurisdictions require.

Reading the per-unit rate correctly

The per-unit transfer tax is where careful reading earns the point. A rate quoted per 500 dollars and a rate quoted per 1,000 dollars produce very different unit counts on the same sale, so identify the denominator first. On a 240,000 dollar sale, a rate of 2.00 dollars per 1,000 gives 240 units and 480 dollars of tax, while the same 2.00 dollars per 500 gives 480 units and 960 dollars.

When the price is not an exact multiple of the unit, most jurisdictions round the number of units up to the next whole unit before multiplying. A 240,400 dollar sale at 1.00 dollar per 500 yields 480.8 units, which rounds to 481 units and 481 dollars. Always round the unit count, not the final tax, unless the problem states otherwise.

Investment math: cap rate and cash flow

Net Operating Income (NOI) = Gross Income - Operating Expenses (excluding debt service). Capitalization rate = NOI / Value. These three rearrange like the percentage triangle:

• Value = NOI / Cap Rate
• NOI = Value x Cap Rate
• Cap Rate = NOI / Value

Example: a property generates 48,000 dollars NOI and comparable cap rates are 8 percent. Value = 48,000 / 0.08 = 600,000 dollars.

GRM and the debt-service distinction

Gross Rent Multiplier (GRM) = Price / Annual Gross Rent is a quicker, less precise screen that ignores expenses. A property priced at 480,000 dollars renting for 48,000 dollars a year has a GRM of 10. Apply a market GRM to a subject's rent to estimate value: rent of 60,000 dollars at a GRM of 9 implies a 540,000 dollar value.

The most tested distinction in this section is what NOI excludes. NOI subtracts operating expenses, taxes, insurance, management, maintenance, but it does NOT subtract the mortgage payment. Debt service is deducted after NOI to reach before-tax cash flow. Candidates who subtract the loan payment when computing NOI deflate it and arrive at a wrong cap rate or value every time.

Worked Example: Property Tax Proration

At closing the seller owes taxes for the days they owned the property; the buyer takes over from the closing date. Most exams use either a 360-day (banker's) year or a 365-day year, read the prompt to see which.

Worked example using a 360-day year (30-day months), annual taxes of $3,600, paid in arrears, closing on April 16, with the seller responsible through the day before closing (April 15).

• Daily tax = $3,600 ÷ 360 = $10 per day.
• Seller's days = Jan (30) + Feb (30) + Mar (30) + 15 days of April = 105 days.
• Seller's share (a debit to the seller, credit to the buyer because taxes are paid in arrears) = 105 × $10 = $1,050.

If the question used a 365-day year, daily tax = $3,600 ÷ 365 = $9.863, and the seller's actual calendar days (Jan 31 + Feb 28 + Mar 31 + Apr 15 = 105) would give 105 × $9.863 = $1,035.62. Always confirm the year basis and who pays the day of closing before computing.

Worked Example: Cash-on-Cash Return

Investors compare deals with cash-on-cash return = annual before-tax cash flow ÷ cash invested, which, unlike the cap rate, does account for the loan.

Worked example:

• Net operating income (NOI): $48,000.
• Annual debt service (principal + interest): $33,000.
• Before-tax cash flow = $48,000 − $33,000 = $15,000.
• Cash invested (down payment plus closing costs): $150,000.
• Cash-on-cash return = $15,000 ÷ $150,000 = 10%.

Keep the two metrics distinct: the cap rate uses NOI before debt service and measures the property's unleveraged yield, while cash-on-cash uses cash flow after the loan payment and measures the investor's leveraged return on actual dollars in. The exam will offer both as answer choices, so match the metric to the numbers the prompt provides.