Anyone you ask about their first experience buying a home and attending the closing will likely tell you that it was confusing in some aspects and the settlement statement was a mass of numbers that required a lot of explanation.
One section of the settlement statement involves pro-rating certain items that are to be split between the buyer and the seller. The closing is at some point during the year, let’s say June 30th. The seller is liable for certain expenses and taxes up to the date the home changes hands and the buyer takes over from there. However, since the taxes are billed annually at the end of the year, they haven’t been paid yet.
Taxes are a major item. Real estate taxes accumulate during the year, but are normally billed out near the end of the year for payment for the entire annual bill due. So, if taxes are $5000 per year for a property, the seller owes their portion up through the closing date and the buyer is responsible for the remainder. If the seller has been paying taxes, maybe a six month payment, then the closing that falls in the last half of the year will only prorate the remaining amount. However, in our example here, no taxes are paid until billed at the end of the year.
In this case, we take a 365 day year and divide that into our $5000 tax bill for a daily tax amount of $13.70. We got that by first dividing $5000 by 365 days to get a daily tax rate. That comes to $13.70/day. Then we are counting the days in the year through our June 30 closing date, which comes to 181 days. 181 days multiplied by our daily taxes of $13.70 = $2479.70 in taxes that the seller owes for the period they have owned the property. So, since the taxes aren’t paid until the end of the year when the new buyer is in residence, the buyer gets a credit that reduces the cash owed at closing by $2479.70. Then the buyer is responsible for the entire $5000 tax bill when it comes due.
Other expenses that must be prorated are handled the same way.
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