Prorations In Real Estate

Prorations In Real Estate

When it comes time for closing, how do the buyer and seller handle the property taxes, utilities, and other items transferred mid-billing-cycle? That's what we're diving into today. 

Prorations are a great tool in real estate! Traditionally they are handled by your real estate agent or the closing agent at the title company. A few we'll look at include: taxes, utilities, LP fuel & fuel oil, and rents. 

Taxes

When drafting your offer to purchase, you have the option of electing how the taxes shall be handled at the time of closing. If you are purchasing an existing home, it's most common to prorate the taxes based on the last year's property tax bill. Remember property taxes are paid in arrears. Meaning the bill for the 2024 property taxes will come out at the end of the year - often December 2024 or early January 2025. Let's say you close on June 1, 2024, how will you know the appropriate amount of tax to pay? That is where the proration comes in. 

The closing agent will use the previous years tax bill to calculate the daily tax rate (taking the total bill divided by 365 days in a year). From there, they will calculate the number of days from January 1, 2024 through the closing date, June 1, 2024, giving us 152 days. They take that number of days multiplied by the daily tax rate to give you your tax proration figure. Now, how that is handled is because the sellers have owned the property through the closing, the sellers will give the buyers a credit for that amount. When the true tax bill comes out at the end of the year, the buyers (new owners) will be responsible for that amount in full (but remember, the sellers did contribute "their portion" from when they owned the property). It isn't "perfect" as from year to year taxes fluctuate, but in most cases, it's fairly close and when the offer is signed, both the seller and buyer are agreeing to conduct the proration. 

There are other options for calculating the taxes that vary based on purchasing circumstances. For example, if you are buying a new construction home, the previous tax bill may only be $200 in 2023, because that is the tax bill for the vacant lot. Now your $350,000 home sits on the lot and at the end of 2024, the tax bill is sure to jump up significantly, now that construction is complete. Doing a basic proration based on last years tax bill may leave the buyer will a larger tax burden than anticipated at the end of the year. In this case, most agents will recommend calculating the tax bill based on the municipal mill rate and then re-assessing at the end of the year when the tax bill comes out to correct it. Make sure to consult with your agent when drafting your offer.

Utilities

When it comes to utilities, again refer back to the offer to purchase. If the property is in town, in most cases, the title company will order a final water/ sewer reading. That means the seller will get a final bill from the date of the last quarterly billing date through the date of closing, and the buyer will start fresh at a $0 balance due, and get their next bill when the next quarterly bill arrives. 

Water/sewer may also be prorated as well. Again, the closing agent would obtain a copy of the last quarters bill to calculate the daily usage cost and multiply that by the number of days from the start of the quarter through the closing date to determine the prorated water/sewer balance. That would be a credit from the seller to the buyer, so when the next water/sewer bill comes out, the buyer would be responsible for that amount in full (remembering the sellers did contribute their portion).

When it comes to natural gas and electric services, most companies do not do prorations. Instead, they ask both the buyer and seller to call and request a transfer of service. This allows the seller to get one final bill and allows the buyer to start at a $0 balance due when they close.

LP Fuel (Liquid Propane) & Fuel Oil 

If the property is out in the country, it likely doesn't have a natural gas line extending to the premise, but more likely it has an above ground or below ground LP fuel tank. Most of the time there is left over fuel in the tank at the time of closing. How do the buyers compensate the sellers for that remaining fuel? Again, always go back to the offer to purchase. It depends how it's specified in the offer, whether that fuel is included at no charge, or if it shall be prorated. 

If it shall be prorated, the agent or seller would take a picture of the LP fuel gauge to see the percentage of fuel that remains. Then, we would multiply that by the number of gallons in the tank (most common tank sizes are 500 gallon and 1,000 gallon). From there we would call the local fuel provider to obtain the current daily fill rate. We then multiply the daily fill rate by the remaining gallons in the tank to get our total cost.

As an example - let's say the tank is 50% full and it is a 500 gallon tank = that leaves us with 250 gallons remaining. We multiply the daily fuel rate of $1.99 by the 250 gallons and get $497.50.

Depending on when this is calculated determines how it will be paid. Traditionally it is calculated 3 - 5 days prior to closing. If it's during the summer, not much LP fuel is likely being used, if it's the dead of winter, perhaps the buyer and seller want to calculate the amount closer to closing to get a more accurate figure. 

The buyer will pay for the remaining fuel in the tank either in the form of a check, cash or as a credit from the buyer to the seller at the time of closing. 

It's commonly misunderstood that the price per gallon rate used is what the seller's paid for the fuel when they filled up the tank. The price of fuel fluctuates daily, so unless specified in the offer, the pre-written language states "the current fuel rate" meaning what the current rate is and not the price is cost the seller to fill it initially.

The same concept applies for fuel oil, which is a fuel tank, often located in the basement of older homes or country properties. Most properties have been updated to natural gas if they are in the city limits, but there are still a handful that still use fuel oil in Wausau and surrounding areas.

Rents

Last but not least, we have rents when it comes to purchasing an occupied investment property. If you aren't closing at the end of the month or the 1st, you'll likely need to prorate the rents, unless specified otherwise in the offer to purchase.

The closing agent will take the monthly rental income and divide it by the number of days in the month of closing to calculate the daily rate. They'll take that daily rate and multiply it by the number of days from the 1st of the month through closing to calculate the prorated rent amount. 

This prorated rent, along with the full security deposits, will get transferred from the seller to the buyer at the time of closing.

Wow! That was a lot on prorations. I hope this article has been helpful for you! If you have questions or want to learn more about a specific topic, drop us a line! We'd be happy to help.

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