Transfer Taxes: Cutting Out the Noise

[David Haynes]

I wanted to share what I have learned about transfer taxes, how they affect the value of homes, and ultimately your profitability. It can be tricky, so I wanted to share my research and some conclusions.

First of all, transfer taxes are so incredibly different from state to state. Check out this summary. For those investing inter-state, it can become quite a headache understanding those differences. I am in Pennsylvania where the transfer tax is seemingly simple. But there are even more differences to be discovered among Pennsylvania’s counties. Philadelphia has a 4.278% tax on the exchange of real estate. This can be split between the buyer and seller or paid fully by the buyer. The neighboring counties (Montgomery County and Delaware County) have a transfer tax of 2%. The state of PA sets the base level of 1%. Counties have the freedom to add on top of that.

The biggest question is how this plays into the value of the home and, ultimately, the bottom line of the investor's analysis. In PA, the transfer tax has become a bargaining tool. “I’ll accept $100,000 if you pay the full transfer tax.” For someone adept at finance, this trick makes no difference. For a novice investor, it can be a bit confusing. Essentially, every investor must realize how the tax can affect their profitability. I personally have set up an excel sheet with drop-down boxes allowing me to choose between “split and full” and “Philly/Montco/Delco”. It cuts out all the noise as I analyze a deal. It may be helpful to do the same. Otherwise, you'll be fumbling with your calculator when every second counts.

I want to address a misconception I have seen. Some investors focus on low transfer tax counties assuming it saves them money and protects their investment. However, for buy-and-holders, the opposite may be true. Research has shown that the introduction of a transfer tax or the raising thereof has an IMMEDIATE effect on the value of a home. A newly introduced transfer tax affects the current homeowner, not subsequent homeowners.

One can assume that high transfer tax counties have a lower probability of raising the tax in the future. Low transfer tax counties have a higher probability of raising that tax. Buying in Delaware County (2%), as opposed to Philadelphia (4.278%), actually increases your chances of losing value if the 2% tax rate were increased. So avoiding a high transfer tax county is counterproductive. For flippers, this risk is minimal, since their investment is short-term.

In conclusion: Firstly, transfer taxes can be difficult to navigate but don’t be distracted by its noise. Ultimately see how it affects your profitability. This is a numbers game. Don't let negotiation fool you. Secondly, don’t think that lower transfer tax counties or states are a safe haven. The opposite could prove to be true. Low transfer tax counties have a higher probability for future increases. Nevertheless, a 1% increase is not going to break you. 

How have transfer taxes affected your investments? Have you ever considered it a deal-breaker? Why? Is there anything that makes your state/county tax unique? I would love to hear about it.