8.3 Proration, Transfer Tax, and Investment Math
Key Takeaways
- Proration finds a daily rate (annual amount / 360 in the banker's year), counts each party's days, then debits or credits at closing.
- Taxes in arrears are a seller debit and buyer credit; prepaid items are a seller credit and buyer debit.
- Transfer tax = (sale price / stated increment) x rate, rounding up partial increments; confirm whether the increment is per $100, $500, or $1,000.
- Value = NOI / cap rate; NOI excludes mortgage debt service, and a higher cap rate produces a lower value.
- Compute percent gain or loss against the original cost, and divide a sale price by (1 + gain rate) to recover the original cost.
Proration: Splitting Shared Costs at Closing
Proration divides an expense or income between buyer and seller based on who owned the property when it was incurred. Property taxes, prepaid HOA dues, rent, and interest are the usual items. The method has three steps: find the daily rate, count the days each party is responsible for, then debit or credit accordingly. The seller pays through the day of closing on most exam conventions unless told otherwise, so always note the closing-day rule the question states.
The 360-Day (Banker's) Method
Most license exams use the statutory or banker's year: 360 days, with each month treated as 30 days. The daily rate is the annual amount divided by 360.
Example: Annual property tax is $3,600; closing is March 16; seller pays through the day of closing.
- Daily rate: 3,600 / 360 = $10 per day
- Seller's days: Jan (30) + Feb (30) + Mar (16) = 76 days
- Seller's share: 76 x $10 = $760
If taxes are paid in arrears (unpaid), the seller owes $760, shown as a seller debit and a buyer credit at closing. The buyer will later pay the full bill and has been compensated for the seller's portion.
Debit, Credit, and Arrears vs. Prepaid
Direction matters as much as the dollar figure.
| Item | Who used it | Seller side | Buyer side |
|---|---|---|---|
| Taxes in arrears (unpaid) | Seller, not yet paid | Debit | Credit |
| Taxes prepaid | Seller paid ahead | Credit | Debit |
| Rent collected by seller | Tenant prepaid month | Debit (owes buyer) | Credit |
Arrears means the cost has not been paid, so the seller owes their used portion (seller debit). Prepaid means the seller already paid beyond closing, so the buyer reimburses the unused portion (seller credit). Misreading this direction is the most frequent proration error.
Annual taxes of $2,400 are unpaid (in arrears). Closing is on April 30 using a 360-day year, and the seller is responsible through the day of closing. What is the seller's prorated share?
Transfer Tax and Recording Charges
Many states levy a transfer (conveyance or documentary stamp) tax when the deed is recorded, calculated per increment of the sale price. The exam states the increment and rate; you apply them.
Example: A transfer tax of $0.50 per $500 of price on a $300,000 sale.
- Number of increments: 300,000 / 500 = 600
- Tax: 600 x $0.50 = $300
If an increment is partially filled, most jurisdictions round up to the next whole increment. Read whether the figure is per $100, per $500, or per $1,000; using the wrong increment is the standard transfer-tax trap. Transfer tax is customarily a seller cost unless the question says otherwise.
Investment Math: Capitalization Rate
Income property is valued by the income approach using net operating income and a capitalization rate.
Value = Net Operating Income (NOI) / Capitalization Rate.
NOI is gross income minus operating expenses and vacancy, but before mortgage debt service. Debt service is never subtracted when computing NOI. A building with $60,000 NOI at an 8% cap rate is worth 60,000 / 0.08 = $750,000. Rearranged, Cap Rate = NOI / Value and NOI = Value x Cap Rate. A higher cap rate signals more perceived risk and yields a lower value for the same income.
Worked Income Problem
A fourplex collects $4,000 per month in rent. Vacancy is estimated at 5%, and annual operating expenses are $18,000. The buyer's target cap rate is 7%.
- Gross annual rent: 4,000 x 12 = $48,000
- Less 5% vacancy: 48,000 x 0.05 = $2,400; effective income $45,600
- Less operating expenses $18,000 -> NOI = $27,600
- Value: 27,600 / 0.07 = $394,286 (rounded)
Do not subtract the mortgage payment; that converts NOI into before-tax cash flow, a different figure the exam keeps separate. NOI is debt-free by definition.
An office building generates $90,000 in net operating income. An investor requires a 9% capitalization rate. What is the maximum value the investor should pay?
Gross Rent Multiplier and Equity
A quick income screen is the gross rent multiplier, which relates price to rent without expenses.
GRM = Sale Price / Gross Annual Rent (or monthly rent for a monthly GRM).
A $360,000 property renting for $3,000 per month carries a monthly GRM of 360,000 / 3,000 = 120. Applied in reverse, a comparable charging $3,200 per month at a market GRM of 120 implies a value of 3,200 x 120 = $384,000. GRM ignores vacancy and expenses, so it is a screening tool, not a substitute for cap-rate analysis. Equity, separately, is value minus what is owed: a $300,000 home with a $185,000 mortgage holds $115,000 in equity.
Profit, Loss, and Appreciation
Percentage of profit uses the original cost as the base, not the sale price.
Percent gain = (Sale - Cost) / Cost.
A property bought for $200,000 and sold for $250,000 gained 50,000 / 200,000 = 25%. To find an original cost from a sale price and a known gain, divide by (1 + gain rate): a property sold for $230,000 after a 15% gain cost 230,000 / 1.15 = $200,000. For a loss, the divisor is (1 - loss rate). Always anchor the percentage to the original cost; using the sale price as the base is the recurring profit-and-loss trap.