8.3 Proration, Transfer Tax, and Investment Math
Key Takeaways
- Prorations allocate annual costs between buyer and seller at closing based on days of ownership.
- Use the 360-day banker's year unless the problem specifies actual/365 days.
- Transfer and recording taxes are charged per a stated dollar amount of consideration (e.g., per $500).
- Capitalization rate links value and income: Value = Net Operating Income / Cap Rate.
- The seller typically pays through the day of closing; the buyer owns and pays from the next day.
Proration mechanics
Prorations divide an annual expense (taxes, HOA dues, prepaid rent, insurance) between seller and buyer based on who owns the property each day. The default exam convention is the 360-day banker's year with 30-day months, though some questions specify a 365-day actual year. Always note who pays through the closing day.
Daily rate method
- Find the annual amount.
- Divide by 360 (or 365) to get a daily rate, or by 12 for a monthly rate.
- Multiply by the number of days/months each party owns.
Example: Annual property tax is $3,600, closing is June 30, and the seller pays through closing in a 360-day year. Seller owns Jan 1 to June 30 = 180 days. Seller's share = ($3,600 / 360) x 180 = $10 x 180 = $1,800.
Prepaid vs. arrears (debit or credit)
Whether the seller is debited or credited depends on who already paid.
| Item paid by | At closing | Entry |
|---|---|---|
| Seller paid taxes in advance | Buyer owes seller for unused days | Credit seller / Debit buyer |
| Taxes paid in arrears (not yet due) | Seller owes buyer for days owned | Debit seller / Credit buyer |
Example: Annual tax $2,400 paid in arrears, closing March 31 (360-day year), seller pays through closing. Seller owned 90 days. Daily rate = $2,400 / 360 = $6.667. Seller's share = $6.667 x 90 = $600, entered as a debit to the seller and a credit to the buyer because the buyer will pay the full bill later.
Annual HOA dues are $1,800, paid in advance for the calendar year by the seller. The sale closes September 30 in a 360-day year, seller responsible through closing day. How much should the buyer reimburse the seller?
Transfer and recording taxes
Transfer taxes are charged per a stated unit of consideration (sale price). Read the unit carefully.
Example: A state transfer tax of $0.70 per $500 of price applies to a $300,000 sale.
- Units = $300,000 / $500 = 600 units
- Tax = 600 x $0.70 = $420
If any partial $500 is rounded UP to a full unit, a $300,200 price would use 601 units (600.4 rounds up). Recording fees may be a flat dollar amount per document and are added separately.
Trap: "per $500" is divided, then multiplied; do not multiply the price directly by $0.70.
Many jurisdictions split a transfer tax between a state rate and a local rate, each quoted per $500 or per $1,000. Compute each rate on the same number of units and add. On the same $300,000 sale, a local tax of $1.00 per $500 adds 600 x $1.00 = $600, for a combined $1,020. Always confirm whether the buyer, the seller, or both pay each portion, because the question may ask only for one party's charge on the closing statement.
Investment property math
Capitalization rate
The income approach relies on: Value = Net Operating Income (NOI) / Cap Rate.
Example: A building produces $48,000 NOI and comparable cap rates are 8%. Value = $48,000 / 0.08 = $600,000. Rearranged, Cap Rate = NOI / Value, and NOI = Value x Cap Rate.
NOI = effective gross income minus operating expenses (it excludes debt service and depreciation). Effective gross income is potential gross income minus a vacancy and collection allowance. If potential rent is $60,000, vacancy is 5%, and operating expenses are $15,000, then EGI = $57,000 and NOI = $57,000 - $15,000 = $42,000.
Gross rent multiplier (GRM)
GRM = Price / Gross Annual (or Monthly) Rent. A property priced at $360,000 with $4,000 monthly rent has a monthly GRM of 90. Apply a market GRM to a comparable rent to estimate value: a comparable renting for $4,500 monthly in a market with a GRM of 90 implies a value of $4,500 x 90 = $405,000.
The critical trap is matching the time period. A monthly GRM uses monthly rent; an annual GRM (often called the gross income multiplier) uses annual rent. Mixing them yields an answer off by a factor of 12, which is a deliberate distractor on the exam.
Return on investment and equity
- ROI = Annual Net Income / Cash Invested. A $9,000 annual return on $120,000 invested = 7.5%.
- Equity = Market Value - Loan Balance. A $400,000 home with a $250,000 loan has $150,000 equity.
Appreciation, depreciation, and basis
Appreciation and depreciation are percentage changes applied to a base value. A $250,000 property appreciating 4% per year is worth $250,000 x 1.04 = $260,000 after one year.
For tax purposes, cost basis = purchase price plus capital improvements minus depreciation taken. If a $300,000 building (excluding land) is depreciated over 39 years straight-line, annual depreciation = $300,000 / 39 = about $7,692. After 5 years, accumulated depreciation is roughly $38,460, lowering the adjusted basis used to compute gain on sale.
Proration Mechanics: Who Owes What at Closing
Prorations divide ongoing costs (taxes, HOA dues, prepaid rent, interest) between buyer and seller as of the closing date. The seller is responsible through (and usually including) the day of closing in many jurisdictions; the buyer owns from there forward. Exams may use a 360-day (banker's) or 365-day year — read the question.
Worked example (taxes): Annual property tax is $3,650, paid in arrears, closing on day 200 of a 365-day year. Daily tax = 3,650 ÷ 365 = $10/day. The seller owes 200 days = $2,000 debit to seller / credit to buyer, because the buyer will later pay the full-year bill.
Transfer Tax and Investment Return
Transfer (conveyance) tax is charged on the sale price, often per $500 or per $100. Worked example: A state charges $1.50 per $500 of price on a $300,000 sale. 300,000 ÷ 500 = 600 units × $1.50 = $900. (Note: Wyoming imposes no state real estate transfer tax — a frequent state-specific point.)
For investment math, capitalization rate = Net Operating Income ÷ Value. Worked example: A building produces $48,000 NOI and sells at an 8% cap rate. Value = 48,000 ÷ 0.08 = $600,000. Lower cap rates imply higher prices/lower risk; raising the cap rate lowers the indicated value.
Annual property taxes of $4,380 are paid in arrears. Using a 365-day year, closing occurs on the 100th day of the tax year, with the seller responsible through the day before closing (99 days). What is the seller's share credited to the buyer?
An apartment building generates $72,000 in net operating income. An investor requires a 9% capitalization rate. What is the maximum the investor should pay?