How Is Rent Prorated at Closing for Income Properties?
Understand how monthly rent is equitably divided between the buyer and seller during an income property sale, a crucial financial step on the closing statement.
When an income-producing property is sold, the rental income for the month of the sale is divided between the seller and the buyer in a process called rent proration. This allocation is based on the number of days each party owns the property during that specific month. The purpose is to compensate the seller for the period they owned the property, while the buyer receives income for the days they will assume ownership. This adjustment is a standard part of real estate closings for rental properties and ensures an equitable financial settlement.
Methods for Calculating Prorated Rent
To calculate prorated rent, two pieces of information are necessary: the total monthly rent and the closing date. The closing date determines how many days of the month the property belongs to the seller versus the buyer. With this information, one of two common methods is used to determine the daily rent rate for the final calculation. These methods are specified in the purchase agreement to avoid disputes.
One approach is the actual days in the month method. This calculation uses the exact number of days in the month the closing occurs, be it 28, 29, 30, or 31. The total monthly rent is divided by the number of days in that specific month to find a daily rent amount. This daily rate is then multiplied by the number of days the buyer will own the property to arrive at the prorated rent figure.
Another calculation is the 30-day method, also known as the banker’s month method. This approach simplifies the calculation by assuming every month has 30 days. The monthly rent is divided by 30 to establish the daily rent, and that amount is multiplied by the buyer’s days of ownership. For example, for a property with a $1,500 monthly rent closing on May 20th, the buyer has 11 days of ownership. Using the actual days method for May (31 days), the buyer’s prorated share is $532.29. Using the 30-day method, the prorated amount is $550 for the buyer.
Applying Prorations Based on Rent Payment Status
How the proration is applied depends on whether the tenant has paid rent for the month of closing. The most frequent scenario is that the tenant has already paid the full month’s rent to the seller. In this situation, the seller has collected income for a period they will not own the property. The seller must credit the buyer for the portion of the month that the buyer will be the owner, ensuring the buyer receives the rental income they are entitled to.
A more complex situation arises if the rent for the month of closing is unpaid. The handling of this scenario should be outlined in the purchase agreement. A common resolution is for the seller to provide a credit to the buyer for the seller’s portion of the uncollected rent. The responsibility for collecting the full month’s rent from the tenant then transfers to the buyer.
This approach protects the buyer from the risk of being unable to collect the seller’s portion of the rent. The purchase agreement may also stipulate other arrangements. For instance, it could state that the seller retains the right to pursue the tenant for their portion of the unpaid rent, while the buyer is only responsible for collecting their prorated share. Clear terms in the contract prevent post-closing conflicts over collection efforts.
Prorated Rent on the Closing Statement
The prorated rent amount is documented on the settlement statement, which details all financial aspects of the transaction. This statement provides a clear ledger of all costs and credits for both the buyer and seller. The proration is listed as a line item for transparency and proper accounting.
On the settlement statement, the prorated rent is recorded as a debit for the seller and a credit for the buyer. A debit represents an amount the seller owes, reducing their net proceeds from the sale. A credit is an amount the buyer receives, which decreases the total cash they need to bring to the closing table.
Security Deposits
Prorated rent must be distinguished from tenant security deposits. Security deposits are not prorated because they are not income, but rather funds held by the landlord to cover potential damages or unpaid rent. At closing, the full amount of any security deposits held by the seller is transferred to the buyer.
This transfer is reflected on the closing statement as a debit to the seller and a credit to the buyer. This ensures the new owner holds the tenants’ deposits as required by law and the lease agreements. The buyer then assumes full responsibility for managing and returning these deposits according to the lease terms.