The transfer of property, such as the sale of a home, can occur at any time of the year. Because some real estate expenses are paid on an annual basis or paid as a fixed amount each month, they need to be prorated when the property sells. The term is also used in the rental of commercial space.
Prorate derives from the term "pro rata," which means proportionally. It is used to describe the division of real estate expenses according to the proportion of ownership or rental. For example, if a home is sold on April 20, the seller owned the home for 110 days of the year and the buyer will own the home for the remaining 255 days. The seller’s portion of ownership for the year during which the sale takes place is 110 divided by 365, or approximately 30 percent. The buyer’s proportion of home ownership for the same year is approximately 70 percent.
Between Buyer and Seller
At closing, any expenses that were prepaid by the seller are prorated to his portion of ownership. For instance, property taxes are typically paid during January for the entire year. Since the seller only owned the home for 30 percent of the year, the taxes are prorated 30/70 and the buyer reimburses the seller the 70 percent difference. School taxes may have been paid in September of the previous year. The seller lived in the house for 232 days of the school tax year or approximately 64 percent. The school taxes will be prorated 64/36 and the buyer will reimburse the seller 36 percent of the school taxes.
Between Bank and Seller
Depending upon the terms of the loan, several items might be prorated and paid to the bank. For example, the bank prorates interest to the start of the loan. When property is sold, the first mortgage payment is typically due the first day of the second month following the sale. In the case of an April sale, the first payment would be due June 1. The amount of interest in that payment is for the previous month -- in this case, the month of May. But in this example, the owner had the loan since April 20. At closing, the bank will prorate the interest expense for the balance of the month of April, to be paid by the buyer.
A commercial property owner typically rents space by the square foot. But many commercial properties have common areas that cannot be rented separately, even though they represent expenses to the building owner. Such areas include a lobby, restrooms and hallways. The building owner totals up the annual expenses for the common area and divides the dollar amount by the total amount of rental square footage in the building. He then prorates these expenses to the renters based upon the amount of square feet they are renting. For example, if a tenant rents 1,000 square feet of space, and the common area expenses are $.50 per square foot, the landlord will charge the tenant an additional $500 per year.
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