What is a transfer tax in real estate? A smart buyer’s guide

When closing on a home, you can expect to pay for several different closing costs. These include fees charged when property ownership changes hands – otherwise known as transfer taxes. Think of it like the government’s cut when you purchase or sell real estate.

Exactly what is a transfer tax in real estate, you wonder, and how does it work? What is the real estate transfer tax based on, who pays the transfer tax, and when does a transfer tax become payable? Read on for answers to these and other important questions.

What is a transfer tax in real estate and how does it work?

A real estate transfer tax is a one-time tax fee imposed when real property – the home you purchase or sell – changes ownership.

“When a home is sold and the deed is recorded, some states, counties, and/or municipalities charge a tax for that transfer, which is a percentage of the sale price that ends up getting rolled into your closing costs,” explains Taylor Kovar, a Certified Financial Professional. “A lot of people don’t realize that transfer taxes exist until they are already at the closing table, which is why it can suddenly feel like it comes out of nowhere for many home buyers.”

How are transfer taxes determined?

Transfer taxes are often levied as a percentage of the property’s sale price or fair market value – often as a fixed dollar amount per $500 or $1,000 of value, according to Jake Leahy, a tax attorney at Airdo Werwas, LLC in Chicago.

“If you purchase a home in Chicago, for example, transfer taxes are layered. Illinois imposes a transfer tax of $0.50 per $500 of value, and Cook County imposes an additional $0.25 per $500; then, the city of Chicago imposes a separate municipal transfer tax totaling $5.25 per $500. So, on a $500,000 home sale in Chicago, the total transfer taxes would be $6,000.”

However, there is no universal formula because every state and local government sets its own rates.

“So the number can look very different depending on where you are buying or selling,” adds Kovar.

A few factors that can determine how much the transfer taxes will be include:

• The property’s value at transfer. Because the tax is usually calculated as a percentage of the property’s sale price or market value, higher-value properties generally result in higher transfer taxes.

• The type of property involved. Residential properties can be taxed at different rates, depending on local laws and economic policies, compared to industrial or commercial properties.

• Area tax rates: Transfer tax percentages vary by state and may also differ at the county or city level, which can significantly affect the total amount owed.

Who pays the transfer tax?

Who ends up paying transfer taxes will depend on state rules, local norms, and negotiations. In many markets, it’s often the seller, while in other markets it’s the buyer; or, this can be negotiated between the seller and buyer. Sometimes, both parties split the tax fees 50/50.

“For sellers, transfer taxes directly reduce net sale proceeds, while for buyers they increase the cash required at closing – which is why they should be factored into deal economics early on,” advises Leahy.

Your title company or closing attorney typically collects transfer taxes at closing and sends the funds to the appropriate office.

“The transfer tax itself is paid to the government entity charging it, usually collected through the county recorder or clerk as part of your closing,” Kovar notes.

When do you pay transfer tax?

Again, transfer taxes are commonly paid at the time of closing when the house deed is recorded. Other scenarios that can trigger transfer taxes include:

• Divorce settlements. Although transfers between spouses are typically exempt, a tax can be accidentally triggered if the new deed is not explicitly recorded as a transaction as part of a divorce settlement.

• Foreclosure or deed in lieu. If you surrender a property to a lender – whether voluntarily to avoid foreclosure or via the foreclosure process itself – transfer taxes can apply in some jurisdictions, especially if the property is transferred to a private party rather than a government agency.

• Co-op share transfer. If you purchase a co-op unit, this involves buying corporate shares rather than real estate, so it may avoid transfer taxes, but many states now tax these share exchanges just like standard property deeds.

• Refinancing your home. “This sometimes triggers a new transfer tax if your state treats it as a new deed transfer,” says personal finance expert Andrew Lokenauth.

• Adding or removing someone from a deed.

• Gifting property to family members.

• Transferring property into a trust or LLC, in certain jurisdictions.

The good news is that you usually don’t have to pay transfer taxes when you inherit property in most states. However, estate tax may apply on inherited property if the total estate exceeds federal or state exemption limits, which is separate from standard transfer taxes.

Types of real estate transfer taxes

Several different kinds of transfer taxes may apply to your real estate transaction. Let’s take a closer look at each:

• State transfer tax. This is the base tax imposed by your state government, which is typically calculated on the full sale price. “Rates from zero in Texas to about 2% in states like Delaware,” says Lokenauth.

• County transfer tax. Your county can add its own tax on top of the state tax.

• Local/municipal transfer tax. Towns and cities can add their own transfer taxes, as well.

• Documentary stamp tax. “These are levied on the recording of deeds or transfer documents and are often calculated per $100 or $1,000 of value,” says Tom O’Saben, director of Tax Content and Government Relations for the National Association of Tax Professionals. In some states, like Florida, there is a documentary stamp tax instead of a traditional state transfer tax.

• Mortgage recording tax. “These apply when a mortgage or deed of trust is recorded and are based on the loan amount rather than the property value,” O’Saben continues. Mortgage recording tax is paid by the borrower/buyer.

• Other taxes. Additional transfer-related taxes or fees can be levied in special taxing districts or to certain types of properties, such as luxury or “mansion” taxes, per O’Saben.

States with no real estate transfer tax

A handful of states currently don’t impose a state-level real estate transfer tax, including Alaska, Arizona, Idaho, Indiana, Louisiana, Mississippi, Missouri, Montana, New Mexico, North Dakota, South Dakota, Texas, Utah, and Wyoming, according to O’Saben.

“However, local transfer taxes may still apply in some of these states,” he adds.

Are transfer taxes deductible?

Transfer taxes are typically not deductible as an itemized deduction, unlike estate tax, which may be deductible in certain circumstances at the federal level. But they are usually added to the cost basis of the property for the buyer or treated as a selling expense for the seller, which can impact capital gain calculations if and when the home is sold later.

“For instance, if you paid $5,000 in transfer taxes when you bought the house, you can add that to your purchase price for tax purposes years later,” Lokenauth says. “Sellers get an even better deal because they can include transfer taxes as a selling expense, which reduces your capital gains when you file taxes that year, without having to wait.”

The bottom line

Transfer taxes are often a costly surprise to buyers and sellers when a home is sold. That’s why it’s a good idea to fully understand what you can expect to pay well before closing, especially if you are preparing to relocate to a new city or state.

“Some buyers who are aware of transfer taxes price their homes assuming the buyer will cover these costs,” says Lokenauth. “Get clarity in your purchase contract about who pays what. I’ve seen deals nearly fall apart at closing over transfer tax disputes that should have been settled upfront.”

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Transfer taxes FAQs

Are transfer taxes sometimes called by another name?

Yes, depending on where you live, they may be called deed taxes, conveyance taxes, recording taxes, or documentary stamp taxes.

Is there any way to avoid having to pay transfer taxes?

Transfer taxes usually cannot be avoided on a taxable real estate transfer. However, certain exemptions can apply to specific transactions, such as transfers between spouses, transfers due to death or inheritance, or qualifying reorganizations, depending on your state or local laws. Some first-time homebuyer programs offer transfer tax exemptions or reductions, as well.

What can transfer taxes actually cost?

Transfer taxes can range from a nominal flat fee to more than 2% of the property’s value in high-tax jurisdictions. That means transfer taxes could represent between 10% and 30% of your total closing costs, a significant portion. For example, on a $300,000 home purchase, transfer taxes in a low-tax state/area can range between $1,000 and $2,000 versus $6,000 or more in a high-tax state/area.