Common Settlement Statement Questions: How do pro-rations work?

Pro-rations are one of the trickier parts of a settlement statement.  Parties are often confused about what a pro-ration is and how it works.

The “Adjustments” paragraph of the Virginia Residential Real Estate Contract states in relevant part, “[r]ents, taxes, water and sewer charges, condominium unit owner’s association, homeowners’ and/or property owners’ association regular periodic assessments (if any) and any other operating charges, are to be adjusted to the Date of Settlement.  Taxes, general and special, are to be adjusted according to the most recent property tax bill(s) for the Property issued prior to Settlement Date . . .”

Our standard contract requires that certain charges or expenses must be apportioned between the parties depending on the date of settlement.  The purpose is to make sure that each party is bearing their proportionate cost of whatever the charge or expense happens to be.  For example, if the settlement date is April 10th and the sellers on the transaction paid the HOA fees for the month of April, then the buyer must essentially reimburse the sellers from the settlement date forward (in this example, the end of April) for the HOA fees already paid.  Thus, it is prorated to the date of settlement.  The math is simply calculating the per diem amount of the charge and multiplying that by the number of days necessary.

Prorating property taxes adds an additional hiccup.  In Virginia, property taxes are paid in arrears semi-annually.  So, if a jurisdiction’s property tax bill due date is December 5, 2016, the payment of that bill covers the period from July 1, 2016 to the end of the year.  Thus, whether the bill has been paid or not will determine how the proration will be structured.  For example, if at the time of closing, the property tax bill has not been paid, then in the above example, the seller will have to credit the buyer from July 1, 2016, to whenever the settlement date is, thus covering the tax payment for the seller’s period of ownership.  Practically, the buyer will pay the whole property tax bill when due, but will have already been credited by the seller at closing.  Alternatively, if the seller has already paid the property tax bill, then the proration would work in reverse.  In other words, the buyer would have to credit the seller from the Settlement Date forward to cover the buyer’s ownership in the property for the balance of the remaining tax period.  In our example above, the credit would run from the Date of Settlement to the end of the year.

It can be challenging for some buyers and sellers to visualize pro-rations, but with some explaining and examples, the vast majority will feel more comfortable and therefore, hopefully lead to better settlement experiences and more referrals for their real estate agents.