Tax Implications of Closing and Transfer

Transfer taxes (also called documentary stamp taxes, conveyance taxes, or excise taxes) are imposed by states, counties, and sometimes cities on the transfer of real property. Rates vary dramatically: Delaware charges 4% of purchase price (split between buyer and seller), while some states charge nothing. Common rates range from 0.1% to 2% of the purchase price. For a $5M acquisition, transfer taxes can range from $5,000 to $200,000 depending on jurisdiction. Some jurisdictions offer exemptions for: transfers between related entities, transfers to trusts for the benefit of the same owner, government entities, and affordable housing projects. Transfer tax planning is an important part of pre-closing analysis—the entity structure and transaction structure can sometimes reduce or eliminate transfer taxes.

In many jurisdictions, a change of ownership triggers a reassessment of the property's taxable value to the current market value (purchase price). This can dramatically increase property taxes if the property has been held for many years at a below-market assessed value. California's Proposition 13 is the most well-known example—properties are reassessed to the purchase price upon transfer, with annual increases limited to 2% thereafter. Some jurisdictions offer exceptions for: transfers between spouses, parent-child transfers, transfers to trusts, and transfers to entities where the original owner retains a majority interest. The reassessment impact must be modeled in the pro forma—an underwriter who uses the current property tax amount without accounting for reassessment will overstate NOI and understate the cap rate.

The purchase price must be allocated between land and improvements for depreciation purposes. Land is not depreciable, so a higher allocation to improvements yields larger annual depreciation deductions. Common allocation methods: (1) the property tax assessment ratio (if the county assesses land at 30% and improvements at 70%, use a similar ratio), (2) an independent appraisal allocating value between land and improvements, or (3) a cost segregation study that further allocates improvements into personal property (5-7 year) and land improvements (15-year) categories. Cost segregation can significantly accelerate depreciation: a $5M property that would generate $145,000/year in straight-line depreciation might generate $400,000+ in first-year deductions through cost segregation. The cost basis allocation should be determined before closing and documented in the closing records.