Ch9. Real Estate Taxation — Transfer Tax, Property Tax, and Capital Gains

The US Real Estate Tax Cycle

Real estate is subject to different taxes at each stage of ownership.

Real Estate Tax Cycle:

Acquisition Stage → Holding Stage → Disposition Stage
Transfer Tax         Property Tax     Capital Gains Tax
Recording Fees       (annual)         (federal + state)

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Transfer Taxes (Acquisition)

Overview

Transfer taxes are levied when real property changes hands. In the US, these are imposed by state and/or local governments — there is no federal transfer tax on real estate.

Common names: Documentary transfer tax, deed tax, real estate excise tax (REET), realty transfer fee.

Rate Examples

State	Rate (approximate)
California	$1.10 per$1,000 of value (county) + city add-ons
New York	0.4% (state) + NYC add-ons up to 2.075%
Florida	$0.70 per$100 of consideration
Texas	No state transfer tax
Washington	1.1%–3.0% tiered on sale price

Who pays: Negotiable; varies by local custom. In California, typically the seller pays. In some markets the buyer pays.

Recording Fees

Separate from transfer taxes; charged by the county recorder to record the deed and any mortgage instruments.

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Property Tax (Annual Holding)

Overview

Property tax: An annual ad valorem tax levied by local governments (county, city, school district) based on the assessed value of the property.

Assessment date: Varies by state. Many states assess as of January 1.

Calculation

Annual Property Tax = Assessed Value × Millage Rate

Assessed Value = Market Value × Assessment Ratio

Example:
Market value: $500,000
Assessment ratio: 80%
Assessed value: $400,000
Millage rate: 20 mills (2.0%)
Annual tax = $400,000 × 2.0% = $8,000

Proposition 13 (California) — Key Example

• Caps annual increase in assessed value at 2% per year
• Property is reassessed to market value upon sale
• Base year value is set at purchase price
• Effective rate: approximately 1–1.25% of purchase price

Property Tax Due Dates

Vary by state and jurisdiction. Examples:

• California: November 1 (first installment due), February 1 (second installment due)
• Texas: January 31 (full year due)
• New York: Quarterly or semi-annual depending on municipality

Exemptions

• Homestead exemption: Reduces taxable assessed value for owner-occupied primary residences
• Senior / disability exemptions: Additional relief for qualifying households
• Agricultural use exemption: Reduced assessment for land actively farmed

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Capital Gains Tax (Disposition)

Overview

Capital gains tax: Federal (and often state) tax on the profit from selling a capital asset, including real estate.

Capital Gain = Sale Price − Adjusted Basis

Adjusted Basis = Purchase Price + Acquisition Costs + Capital Improvements
                 − Depreciation Taken (for investment property)

Federal Capital Gains Tax Rates

Holding Period	Rate
Held ≤ 1 year (short-term)	Ordinary income rates (10–37%)
Held > 1 year (long-term)	0%, 15%, or 20% depending on taxable income
Depreciation recapture	25% (Section 1250, investment property)

Primary Residence Exclusion (Section 121)

Up to $250,000 gain excluded** for single filers; **up to$500,000 for married filing jointly.

Requirements:

• Owned the home for at least 2 of the past 5 years
• Used it as primary residence for at least 2 of the past 5 years
• Have not used the exclusion within the past 2 years

Example:
Purchase price: $400,000
Sale price: $750,000
Gain: $350,000

Single filer exclusion: $250,000
Taxable gain: $100,000 → subject to long-term capital gains rates

1031 Exchange (Like-Kind Exchange)

Allows an investor to defer capital gains tax by reinvesting proceeds from a sale into a “like-kind” replacement property.

Rules:
- Must identify replacement property within 45 days of sale
- Must close on replacement property within 180 days
- Equal or greater value required to defer all tax
- Must use a qualified intermediary

Depreciation on Investment Property

Residential rental property: depreciated over 27.5 years (straight-line)
Commercial property: depreciated over 39 years (straight-line)

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Tax Summary Comparison

Transfer Tax   → One-time at acquisition (state/local; no federal)
Property Tax   → Annual (local government; ad valorem)
Capital Gains  → One-time at disposition (federal + state)
Depreciation   → Annual deduction (investment property only; recaptured at sale)

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Key Concept Cards

Primary Residence Capital Gains Exclusion (§121) ★★★★★ : Exclude up to $250,000 ($500,000 MFJ) of gain. Must own AND occupy for 2 of the last 5 years. Can be used once every 2 years. Memory tip: 2-of-5-year rule; $250K single /$500K married

Property Tax Assessment Date ★★★★★ : The date on which ownership is determined for tax purposes varies by state. In California, it is January 1. The owner on that date owes the full year’s tax. Memory tip: Know your state’s lien date — not the due date

1031 Exchange Timeline ★★★★☆ : 45 days to identify; 180 days to close. Must use a qualified intermediary to hold funds. Any cash received (“boot”) is taxable. Memory tip: 45/180 — identify/close

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Practice Quiz

Q. A married couple bought their home for $600,000 and sold it for$1,050,000 after living in it for 3 years. What are the federal income tax implications?

Gain = $450,000. Married filing jointly exclusion =$500,000. Since the gain ($450,000) is less than the exclusion ($500,000), and the 2-of-5-year requirement is met, the entire gain is excluded from federal income tax.

Q. Who owes property taxes on a California property sold on February 15?

Property taxes in California are based on ownership as of January 1. The seller owned the property on January 1 and therefore is responsible for the full tax year. At closing, taxes are typically prorated between buyer and seller, but the legal obligation for the year’s taxes was established on January 1.