Selling a property can be an expensive endeavor. Although savvy investors try to make more money than they lose when selling a property, there are several expenses that come into play during the transaction.
One of the expenses is real estate transfer tax.
What are real estate transfer taxes?
When a property is sold, the real estate title is transferred from the seller to the buyer. "Title" is just the legal way of saying that a person has full ownership over something.
There's a fee to complete this transfer -- that fee is real estate transfer tax. It's usually calculated as a percentage of the sale price of the home.
The amount of the fee varies based on where you live. Depending on where you buy or sell a home, you might have to pay taxes at the city, county, and/or state level.
To take that one step further, if you receive property as a gift or inheritance, you may have to pay taxes at the federal level. This transfer tax is typically called an estate tax or gift tax.
There's an additional tax type called "optional" transfer tax, too. The county government decides whether they want to charge this optional transfer tax. The option isn't given to the taxpayer, as the name might suggest.
Can I deduct real estate transfer taxes?
Real estate transfer taxes are not deductible. While that may sound unfortunate, there are several ways in which transfer taxes can still be optimized.
How can real estate transfer taxes be optimized?
If you buy a real estate investment or rental home, the transfer taxes can be deducted as a work expense. On the flip side, if you buy a primary residence, the transfer tax cannot be deducted.
Here's the good news: Transfer taxes can save you money down the line. The transfer tax becomes part of the cost basis of the property. To make this easier to understand, let's break down what cost basis means. Here's how you calculate it:
- Take the price you paid for your home.
- Add the cost of transfer taxes, title insurance, and any improvements you've made to the home, such as putting in new windows, renovating the bathrooms, or adding new appliances.
- Subtract the amount that the home has depreciated, if applicable.
The final number is your cost basis.
When a home closes, the seller typically needs to pay capital gains tax. This is a tax on the home's increase in value. To determine the capital gains tax on your property, subtract your cost basis from the home's sale price. If your property lost value, you can deduct the difference between your capital losses and capital gains on your tax return. There are some limitations, however. The IRS limits the deductible loss to $3,000 per year. If you're married and file separate tax returns, your loss is limited to $1,500.
It's also important to note that capital gains taxes and transfer taxes aren't the same. If you've lived in your home less than two years, you may need to pay both.
Most states assess capital gains tax on the difference between your cost basis and what you sell the home for. The higher your cost basis, the lower your capital gain. This means you'll pay less in capital gains tax when the property is sold. Let's break that down in an example.
Say you buy a home for $400,000. Several years down the line, you put the house up for sale and it sells for $700,000. Your capital gain on this property is $300,000.
As a general tax rule, if you're filing taxes as single, you pay taxes on gains that exceed $250,000. This applies to all primary residences, regardless of the state the property is in. If you file jointly as a married couple, you need to pay taxes on gains that exceed $500,000.
Using the example above, a married couple wouldn't pay capital gains tax because their capital gain is below the $500,000 threshold (it's $400,000 in the example above). If you file as single, however, you'd pay capital gains tax on $50,000 (the $300,000 profit from the sale of the house minus your $250,000 cost basis).
If you spent $10,000 in transfer taxes when you initially purchased the $400,000 property, that amount is applied to your home's cost basis. So your cost basis is adjusted to $410,000. That means you netted a profit of $290,000. Take out the $250,000 deduction, and you're taxed on the remaining $40,000.
Because you spent $10,000 in transfer taxes, you won't be taxed as heavily on capital gains, saving you money in the long run. Pretty cool, right?
Is it always called real estate transfer tax?
This varies. Some states and cities call it deed tax, deed transfer tax, mortgage registry tax, or stamp tax.
Who pays the transfer tax?
Real estate transfer taxes can be paid by the buyer, seller, or both. It varies based on the real estate market and the state where the transaction takes place. The seller typically pays the tax in most states.
What happens if only a percentage of a property is being sold?
If you co-own a property and sell your portion, you still need to pay real estate transfer tax. However, the tax is only calculated on the portion of the property that you own. For example, if you own 50% of the property, you'll be taxed on half of the property value.
Who imposes transfer taxes?
This varies by state. Some states impose a transfer tax at both the state and local level, making transfer taxes quite costly.
If I can't deduct transfer taxes, what can I deduct instead?
When you buy a home, you make several payments called closing costs. Although you cannot deduct transfer taxes on your personal home, you can deduct the mortgage interest and certain property taxes the year that you buy your home. That alleviates some of the tax burden.
How much is transfer tax?
Transfer tax varies by state, but it's typically a percentage of the sale price or market value of the home. Most state laws make transfer tax a set rate for every $500 of the property value. For example, if the transfer tax rate is 0.3%, it may be described as $1.50 for every $500.
To give you an idea of the range in transfer taxes, here's a breakdown of transfer tax rates in a few states.
|State||Transfer Tax||Who Pays the Tax?|
|California||$0.55 per $500||Variable, but typically paid by the seller|
|Florida||Home's sale price/$100 x .70||Variable, but typically paid by the seller|
|New York||Homes below $3M: 0.4% Homes above $3M: 0.65%||Variable, but typically paid by the seller|
|North Carolina||$1 per $500||Variable, but typically paid by the seller|
|Colorado||1–2%, depending on which part of Colorado you're in||Typically split between the buyer and seller|
|Pennsylvania||2% of the home's sale price||Split 50/50 between buyer and seller|
Will real estate transfer taxes still be imposed if I'm a first-time homebuyer?
Depending on the state, real estate transfer taxes may not apply if you're a first-time homebuyer.
If they do apply, they may be less than average.
In addition to transfer taxes, what other fees I should be aware of?
When selling a home, some states or counties might also charge a recording fee. This is a fee charged for making the real estate transaction a public record. It's typically charged by the county, as counties keep all property sale and purchase records.
If you get a mortgage, you also need to pay a mortgage recording tax for documenting the loan transaction. This is a state-imposed fee. Similar to transfer taxes, mortgage recording taxes are a percentage of the sales price.
How does it work when paying real estate transfer taxes on a rental property?
If the property isn't your primary residence, paying real estate transfer taxes is a bit different. You can deduct real estate transfer taxes on your tax return if the property is a rental property.
As a buyer or seller, it's important to understand the costs of a real estate transaction.
It's also important to include who's paying the transfer tax in the sales contract. Failing to do so may mean you'll pay far more than you originally bargained for when selling a home.