What Is a Proration in Real Estate?

Real estate transactions involve financial adjustments to ensure an equitable property transfer. Proration divides shared expenses between a buyer and seller at the time of property transfer. This ensures each party is financially responsible only for the period they hold ownership. It prevents either party from overpaying or underpaying for ongoing property costs.

Understanding Real Estate Proration

Proration in real estate achieves fairness in financial transactions during a property sale. It addresses expenses that span billing cycles, ensuring costs are allocated precisely to the period of ownership. For instance, if a property closes mid-month, the seller is responsible for expenses incurred up to the closing date, while the buyer assumes responsibility from the closing date onward.

Many property-related costs are paid in advance or arrears for a specific period, such as a month, quarter, or year. Without proration, one party might inadvertently pay for services that primarily benefit the other. This prevents one party from bearing the entire burden of shared expenses, promoting transparency and reducing disputes between buyers and sellers.

Common Items Subject to Proration

Various expenses are subject to proration in real estate transactions to ensure an accurate division of financial responsibility. Property taxes are a common item, often assessed annually but paid in different cycles, sometimes in arrears or in advance. For example, if taxes are paid for the entire year in January but the property sells in June, the buyer would owe the seller for the portion covering July through December.

Homeowner association (HOA) fees are another common prorated expense, typically paid monthly, quarterly, or annually. If a seller has prepaid HOA fees beyond the closing date, the buyer will reimburse the seller for the unused portion. Similarly, utility bills, such as for water, sewer, gas, and electricity, are prorated to ensure each party pays for their actual consumption up to the closing date. For income-generating properties, prepaid rent is also prorated, where the seller credits the buyer for any rent collected that applies to the buyer’s period of ownership. Other items like fuel in tanks (e.g., oil or propane) may also be prorated, with the buyer reimbursing the seller for the market value of the remaining fuel.

Calculating Prorated Amounts

Calculating prorated amounts involves a systematic approach to determine each party’s share of an expense. A common method is the “actual calendar day” method, which uses the exact number of days in the month or year. Alternatively, some jurisdictions or contracts may use the “30-day month” method, which assumes each month has 30 days and a year has 360 days for calculation purposes.

To perform a proration calculation, identify the total expense for the billing period. Determine the per-day cost by dividing the total expense by the number of days in that period (e.g., 365 days for an annual expense or the exact number of days in the current month for a monthly expense). Multiply this daily rate by the number of days each party is responsible for. For example, if annual property taxes are $3,650 and closing is on June 1st, the daily rate is $10 ($3,650/365 days). The seller would be responsible for 151 days (January 1 to May 31), and the buyer for 214 days (June 1 to December 31), with adjustments made accordingly at closing.

Proration on the Closing Disclosure

Prorated amounts are documented on the Closing Disclosure (CD), a standardized form that details all financial aspects of a real estate transaction. This document provides a comprehensive summary of the buyer’s and seller’s costs and credits. Proration entries appear on the CD as either a credit to one party or a debit to the other, reflecting the allocation of shared expenses.

For instance, if the seller has prepaid property taxes for the entire year, the buyer will see a debit on their side of the CD, representing their share of those prepaid taxes. Conversely, the seller will receive a corresponding credit. The closing agent ensures these calculations are accurately reflected on the CD, and both buyers and sellers should review these figures before the final closing to confirm their understanding and agreement.