Ginny makes an offer to purchase Maureen and Mike’s home. In the two months leading up to the closing, some bills come due that must be paid.
Maureen and Mike pay the water bill (which comes every six months), the second installment of real estate taxes (which are paid in March and September), and the gas bill (which comes once every two months).
On the day of the closing, Maureen and Mike’s attorney tells Ginny the dollar amount of her share of these prorated expenses. Ginny, who has followed her attorneyâ€™s advice and brought a cashier’s check to the closing for just this reason, hands it over and pays her share.
Almost every house closing contains some costs that are prorated between the buyer and the seller. That’s because we don’t pay for our housing needs on a daily basis. Can you imagine trucking on down to the county clerk’s office to pay your real estate taxes every day? What about your electric bills? Water bill? Homeowner’s association fee?
Many of these costs are spread out over a long period of time. Depending on where you live, you pay your real estate taxes once or twice a year. It isn’t fair for Maureen and Mike to have paid an entire year’s worth of property taxes, if they live in the home only nine months of the year.
Likewise, if Ginny bought the home just before the second installment of taxes was due, it wouldn’t be fair for her to pay for six months’ worth of taxes, when she would have only been in the house for only three months.
A little bit of math, called a “proration,” evens things out for anyone. How do you calculate a proration? Identify the calendar days covered by, say, your property tax bill. Then, divide the bill amount by that number of days. That will give you a daily fee for the bill. Then, multiply that fee by the number of days up to and including the closing.
For example, let’s say Maureen and Mike’s property taxes are $2,000 for the year, paid in two installments of $1,000 each on March 15 and September 15. If you divide each $1,000 payment by 183 days in the 6-month period it covers, you discover that the daily cost of the property tax is $5.46.
If the real estate closing is on September 16, the day after taxes are due, Maureen and Mike will have already paid the real estate property taxes for the rest of the calendar year. At the closing, Ginny will have to reimburse them for each day, to the year-end, that she’s going to live in the house.
Continuing with the example, from September 17 to the end of the year is 106 days. If you multiply 106 by the $5.46 daily fee, Ginny’s needs to reimburse the sellers for $578.76, which is her share of the property taxes for that year. (Local custom dictates who pays for, and who receives the benefit for, the day of closing.)
If the tax bills are sent in arrears (that is, you pay this year for last year), the split becomes a little more complicated because the agents and attorneys have to guess at how much the tax bill will go up. So itâ€™s common in some areas to ask the previous owners to pay a little extra in real estate taxes above the daily fee.
Instead of asking for the daily fee multiplied by the number of days, the buyer may ask the seller to put up 110 percent or 120 percent of the daily fee to cover any increases. If you multiply by 110 percent in our example, then the daily real estate tax fee of $5.46 rises to $6.01.
Your real estate attorney (or your broker if you’re in a state where attorneys are not used for house closings) will calculate the prorations for every bill that has some sort of shared time arrangement, including gas bills, water bills, assessments to homeowners’ associations, and real estate taxes.
This may also include any insurance policies (above and beyond homeowner’s insurance required by the lender) or service agreements the buyer will have to pay for.
Some attorneys will also draw up a reproration agreement. If the sellers reimburse the buyer for more than the actual bill, the buyer and seller may agree to recalculate the bill to reflect the actual amount paid.
Here’s how it works: If you thought the bill was going to be $100 and the seller’s share was 25 percent, the seller would have paid you $25. But if the actual bill ends up being only $80, the sellerâ€™s share is only $20, so you would owe the seller $5 (paid after the closing).
Proration cash is sometimes kept in an escrow account (by a disinterested third party), but this usually happens only with substantial sums. The escrow manager then handles the payment of the bills and any reprorations.
But the important thing to remember about prorations is that the seller must pay all of his or her costs before the closing is complete. Otherwise, the buyer may have to chase the seller.
June 17, 2002.