Prorations are used significantly in real estate transactions. They are typically used during a transactions to calculate payments owed or to be recieved. For example, in order for a buyer to determine how much money they will pay on insurance, taxes, mortgage payments or will receive from rent they will prorate the total amount. The most common measurements for prorations are:
- 360 day year
- 30 day month
1) An investor buys a rental property on May 15 that generates $120,000 annually from rent. Seller has already received the rent for May, so they need to prorate the rental payments to determine how much money the seller owes the buyer.
- Divide $120,000/12 months in a year = $10,000
- Divide 15 days/30 day month = 1/2
- Multiply $10,000/2 = $5,000
2) A buyer purchases a home on July 10 with $7,200 in annual taxes. The seller already paid the taxes for the whole year; therefore, they need to prorate the annual taxes in order to determine how much the buyer owes the seller. The buyer is responsible for the remainder of the year, from July 10 - December 31.
- Divide $7,200/12 months in a year = $600
- Multiply $600*5 full months remaining = $3,000
- Divide 10 days/30 day month = 1/3
- Multiply $600/3 = $200
- Subtract $600-$200 = $400
- Add $3,000 + $400 = $3,400