Buying a property in the United States can be a complicated process for first-time homebuyers. Many small and large fees must be paid during the real estate transaction. Some of them are paid for services provided by professionals such as a real estate agent commission fee and an appraisal fee. Other expenses include financing fees such as a mortgage origination fee.
Lastly, there are taxes to be paid at the time of house purchase. While service fees and financing fees are somewhat predictable, taxes may be levied on federal, state, and municipal levels. One of these taxes is a transfer tax that can be charged by state governments, county jurisdictions, and local municipalities.
Transfer tax, also known as conveyance tax, is a charge issued by the government at the time when property ownership is transferred from one party to another. Usually, it is applicable when property ownership is transferred from a seller to a buyer. This tax can be charged by the state, county, and municipal governments.
In addition to that, all three government levels can charge a transfer tax at the same time. For example, New York City charges a transfer tax of 1% for properties that are less than $500,000 in value while New York State charges 0.4% for properties that are less than $3,000,000. This means that the total transfer tax paid on a property under $500,000 in New York City is 1.4% because the tax must be paid on municipal and state levels.
Who Pays Transfer Tax?
Transfer tax is usually paid by the seller when the property ownership is transferred to the buyer although there are cases where a buyer may take on the expense. Depending on the state where a transaction is taking place, it might be mandatory that one or the other pays for the transfer tax.
There are also states where a specific party doesn’t need to pay for this tax. In this case, a buyer and a seller have to negotiate who will take the burden of paying transfer tax. Unless there is a common way to pay for the transfer tax in the area, the result of negotiations is usually determined by the real estate market conditions.
If the real estate market currently favors the sellers, which means that there are more buyers than sellers, then it is likely that the buyer will take on the cost of transfer tax. On the other hand, if there are more sellers than buyers, then the seller may be willing to cover the cost of transfer tax to close the deal.
Regardless of who is paying for it, it is important to understand how much this tax will cost because it will affect the price of a house for a buyer and proceeds from the sale for a seller. Calculating transfer tax may be complicated because not only each state but also each county and municipality has its own rules applied to this tax.
What if It Is a Gift or an Inheritance?
When a property changes hands as a gift or an inheritance, the transfer tax does not apply. Instead, the other two types of taxes may be applied. Depending on the circumstances, a donor or a recipient may have to pay a gift tax or an estate tax on the real estate that is transferred. The good news is that most people receiving a piece of real estate as a gift or inheritance will not need to pay any tax on it.
Moreover, unlike transfer taxes that may be charged on state, county, and municipal levels, gift and estate taxes are charged on the federal and sometimes state levels, which makes it much easier to estimate how much a person may have to pay in taxes.
Generally, an individual can give up to $16,000 annually as a gift without paying any taxes. Of course, most properties are valued much higher than $16,000. That is where a lifetime exclusion for gifts comes into effect. On top of the annual gift allowance, each individual has a lifetime exclusion that allows them to give up to $11.7 million tax-free over their lifetime.
This means that if a person surpasses the annual allowance, the rest of the gift value will simply be deducted against their lifetime exclusion. Only after exhausting the allowance for lifetime exclusion, an individual will have to pay a gift tax of up to 40%. Even though it is easy to surpass the annual gift limit when passing down real estate, most people will never exhaust their lifetime exclusion for gifts.
If a property transfer is the result of an inheritance, an estate tax may be applied. Similar to a gift tax, the estate tax has a very high limit before it starts to be applicable. As of 2022, the estate tax exemption limit is set at $12.06 million, which means that the real estate passed down as an inheritance is not taxed as long as its value is less than $12.06 million.
Some states also charge an estate and inheritance tax although most of the states still tend to avoid charging these taxes. Many states choose not to tax an inheritance because such practice has been criticized as death taxes.
Final Notes on Transfer Tax
Transfer tax is complicated because of the number of jurisdictions that can levy such tax at the same time. It is certainly an expense that a buyer and a seller should be aware of. Even though it is a considerable expense, most of the time a buyer and a seller have to take it as a given because a buyer may not be willing to get a property in another area while a seller cannot sell a house in another area.
The Best Approach for Selling Your House in California and Moving Out of State is to take help from a professional who can act as a bridge between you and the other party. While they might help you smoothen the buying and selling process, they are well aware of the property laws. As a result, they can proceed with the whole process in a way that saves you money in taxes.
This means that often enough a buyer and a seller should not pay too much attention to the difference in transfer tax rates between different regions because they simply cannot get a deal in other regions. Instead, a buyer and a seller should look into other closing costs that can be minimized through negotiations and market research. Closing costs may add up to 3% – 6% of the house price, and a transfer tax is only a small fraction of these costs.