What are Tax Prorations?
Tax prorations are adjustments made during closing to ensure both the buyer and seller pay their fair share of property taxes for the year. Since property taxes are typically paid in advance or in arrears, depending on the location, prorating ensures that each party pays for the portion of the year they owned the property.
Why are Tax Prorations Important?
Without tax prorations, the buyer would be responsible for paying taxes for the entire year, even if they only owned the property for a portion of that time. This would be unfair to the buyer and could create financial hardship.
How are Tax Prorations Calculated?
Tax prorations are calculated using the following formula:
- Total Property Taxes for the Year / Number of Days in the Year * Number of Days Buyer Owned the Property
What Costs are Prorated at Closing?
In addition to property taxes, other costs may be prorated at closing, such as:
- Homeowner’s Association (HOA) fees: If the property is located in a community with an HOA, the fees will be prorated based on the number of days the buyer owned the property.
- Insurance premiums: Any prepaid insurance premiums will be prorated based on the number of days remaining in the policy term.
- Interest: If the buyer is obtaining a mortgage, the interest will be prorated from the closing date to the first mortgage payment date.
Who is Responsible for Paying Prorations?
The seller is typically responsible for paying the prorated taxes and other costs for the period they owned the property. However, the buyer is responsible for paying the prorated costs for the period they will own the property.
How are Prorations Reflected on the Closing Disclosure?
The closing disclosure will list all prorated costs and indicate who is responsible for paying them. This document provides a clear breakdown of all closing costs, including prorations.
What if there is a Dispute about Prorations?
If there is a dispute about prorations, the buyer and seller should work with their respective real estate agents and/or attorneys to reach an agreement. In some cases, mediation or arbitration may be necessary.
Here are some additional tips for understanding tax prorations:
- It is important to review the closing disclosure carefully to ensure that all prorations are calculated correctly.
- If you have any questions about prorations, be sure to ask your lender, real estate agent, or attorney.
- You can use online calculators or consult with a financial professional to estimate your prorated costs at closing.
By understanding tax prorations, you can ensure a smooth closing process and avoid any financial surprises.