Recent measures in California have established massive tax increases on properties sold in certain cities. There is mounting fear among property owners that these trends may spread to other areas within the state.
Beginning on April 1, 2023, the City of Los Angeles began imposing an additional 4% transfer tax on properties sold or transferred for more than $5 million and a 5.5% tax on properties sold or transferred for more than $10 million. This additional transfer tax is in addition to the current county and city transfer tax rates of 0.11% and 0.45%, respectively, increasing the total transfer tax rate to 4.56% on transactions between $5 million and $10 million and to 6.06% on transactions of $10 million or more.
Beginning on March 1, 2023, the City of Santa Monica increased its real estate transfer tax from 0.6% to 5.6% on properties valued over $8 million. Real property transactions between $5 million and $8 million will continue to pay a 0.6% city transfer tax and transactions under $5 million will continue to pay a 0.3% city transfer tax. The foregoing city transfer tax rates are in addition to the 0.11% County of Los Angeles tax rate, which brings the new total transfer tax rate for transactions over $8 million in the City of Santa Monica to 5.71%.
For example, a sale of a $7,000,000 home in the City of Los Angeles incurs a city and county transfer tax bill of $319,200 (4.57%), whereas the seller of a similarly priced home in the City of Beverly Hills pays just $7,700 (0.11%).
These tax increases affect all types of real property, including commercial, industrial, and residential, which is contrary to it being referred to as a “mansion tax.”
State officials justify these large increases to fund needed homelessness prevention initiatives, housing projects, and schools.
Until these initiatives were passed, real estate transfer taxes rarely became issues of concern for buyers and sellers since overall fees were nominal relative to the size of sales transactions. However, a growing number of property owners are now getting very nervous about the implications and impact of new transfer taxes on planned sales of their properties.
In this blog post, we will explain transfer taxes including who is responsible for paying and what you can do to offset this cost.
What are Real Estate Transfer Taxes?
A real estate transfer tax (aka a documentary transfer tax or sales tax) is a charge levied by state and local government on properties when the property is sold to a new owner. State laws and rates for transfer taxes vary greatly. Some states, like Texas, don't have a transfer tax. Others have varied charges depending on the value of the property.
Many readers may not be familiar with the transfer tax because it often isn’t discussed before a property deal is closed. This can result in a large surprise tax hit to the buyer or seller at time of close of escrow.
Further issues can arise since the party responsible for paying the transfer tax is up for negotiation. In California, sellers traditionally have paid this tax – but they are not legally required to do so. Government authorities do not care who pays the tax as long as it gets paid – so this can lead to disagreements that can negatively impact the sales process.
How the Transfer Tax is Implemented
At the point when the ownership transfer document such as the Grant Deed is recorded in the County Recorder’s office where the property is located, a “transfer fee” is collected. The amount of the tax is generally determined by the location of the property and its final sale price.
Can a Transfer Tax be Deducted on Income Tax Returns?
Unfortunately, the IRS (Internal Revenue Service) does not allow property transfer taxes to be deducted from your income tax return. However when you eventually sell the property, transfer taxes might be subtracted from your total capital gain. This indicates that even though the expense cannot be recovered right now, it can in the long run.
When a rental property is sold in the future, an investor can add the initial property transfer tax to the cost basis thereby reducing the overall capital gain tax. If the seller pays the tax, they are considered expenses of the sale and reduce the amount of gain on the sale.
California Transfer Tax Exemptions
There are many exemptions from the California transfer tax including:
• Dissolution of marriage
• Sale approved in court proceedings e.g., filed for bankruptcy.
• Transfer into or out of a trust
• Transfer as result of death
• Transfer due to foreclosure
You can view the full list of exemptions here: https://ccr.saccounty.gov/Documents/TransferTaxExemptions.pdf
Given recent actions by local authorities to significantly raise property transfer taxes, it behooves all owners of California real estate, whether a primary residence or investment properties, to understand the potential impact of these taxes when planning a sale.
Emboldened by measures in LA and Santa Monica, more California cities are likely to take steps to raise transfer tax rates to 1) finance affordable housing and homelessness prevention programs and (2) halt community gentrification initiatives by raising tax rates on new real estate investments.
To avoid transfer tax increases that will significantly affect real estate developers, investors, lenders, and other industry stakeholders in these places, concerned property owners need to be watchful, take the necessary actions, and express their concerns.
Please contact us for referrals to knowledgeable tax advisors or to learn more about real estate tax deferral and investment options.