Prorated Taxes: How They Are Calculated in a Home Sale

Prorated taxes represent the division of annual property tax liability between a home’s seller and its new buyer. This process ensures each party is financially responsible only for the taxes corresponding to the period they owned the property within the tax year. The proration is calculated based on the closing date and handled by a closing agent to guarantee fairness. It prevents the seller from paying for services after they have sold the property and ensures the buyer does not cover tax obligations that arose before their ownership began.

The Role of Prorated Taxes in a Home Sale

The principle behind prorating property taxes is an equitable distribution of the annual tax expense. Because property taxes fund local services for a full year, proration splits the cost based on the number of days each party owns the home. A closing agent executes this calculation, ensuring the seller is responsible for taxes up to, but not including, the closing day. From the day of closing onward, the financial responsibility shifts to the buyer.

Calculating Prorated Property Taxes

To calculate the prorated tax amount, the closing agent needs the total annual property tax bill and the official closing date. The calculation involves determining a daily tax rate, which is then multiplied by the number of days each party is responsible for. The formula is the annual tax amount divided by the number of days in the year, multiplied by the number of days of ownership for each party. Local customs may use a 365-day year or a 360-day year.

A common scenario involves taxes being paid in arrears, meaning the tax bill that is due covers a period that has already passed. For example, a tax bill due on December 31st covers the period from January 1st to December 31st of that same year. If a home sale closes on September 30th, the seller has owned the property for 273 days of the year but has not yet paid the tax bill. If the annual tax is $7,300, the daily rate is $20 ($7,300 / 365 days). The seller’s responsibility is $5,460 ($20 x 273 days), and at closing, the seller gives the buyer a credit for this amount, and the buyer will then pay the full $7,300 tax bill when it comes due.

The opposite situation occurs when taxes are paid in advance, where the tax bill covers a future period. Imagine a jurisdiction where the tax year runs from July 1st to June 30th, and payment is due on July 1st. If a seller pays the annual tax of $7,300 on July 1st and then closes the sale on September 30th, they have prepaid for a full year but only owned the home for 92 days of that tax year. The buyer will own the property for the remaining 273 days. Using the same $20 daily rate, the buyer owes the seller a reimbursement of $5,460, which is paid at closing.

Locating Prorations on Closing Documents

The results of tax proration calculations are documented on the Closing Disclosure, a standardized form used in most U.S. home sales. These figures appear on page 3 in the “Summaries of Transactions” section, which has two columns detailing the buyer’s and seller’s transactions. The prorated tax adjustment will appear as a line item under headings such as “Adjustments for Items Paid by Seller in Advance” or “Adjustments for Items Unpaid by Seller.”

Understanding the terms “debit” and “credit” is necessary to interpret this section. A debit is a charge that a party must pay, while a credit is an amount a party receives. In the scenario where taxes are paid in arrears, the seller’s prorated share appears as a debit to the seller and a credit to the buyer. This credit reduces the amount of cash the buyer needs to bring to closing.

Conversely, when taxes have been paid in advance by the seller, the buyer’s prorated share is shown as a debit to the buyer and a credit to the seller. This debit increases the amount of cash the buyer must pay at closing, as they are reimbursing the seller. The figures are always mirrored; a debit to one party for a specific proration will correspond to an equal credit for the other.