Do You Have to Pay Taxes on a Transfer on Death Deed?
Clarify the tax implications of a Transfer on Death Deed. Understand how various tax considerations apply to property transferred at death.
A Transfer on Death Deed (TODD) is a legal instrument allowing property owners to name a beneficiary who will inherit their real estate directly upon their death, bypassing the probate process. This deed is revocable, meaning the owner can change or cancel it at any time during their lifetime. While TODDs offer a streamlined way to transfer property, their tax implications can be intricate and vary depending on federal and state laws.
Federal Estate Tax Implications
A property transferred through a Transfer on Death Deed is included in the deceased owner’s gross estate for federal estate tax purposes. This means the property’s fair market value at the time of death contributes to the total value of the estate when determining if federal estate tax is owed. The federal estate tax is levied on the deceased person’s estate, not directly on the beneficiary receiving the property.
For individuals dying in 2025, the federal estate tax exemption amount is $13.99 million. Married couples can combine their exemptions, effectively shielding up to $27.98 million from this tax. Due to this high exemption amount, the vast majority of estates do not owe federal estate tax.
If an estate’s value surpasses the exemption, the tax applies only to the portion exceeding the threshold, with rates potentially reaching 40% for the highest value estates. The federal estate tax is typically paid by the estate itself before assets are distributed to heirs. However, current legislation indicates that the increased exemption amounts are scheduled to revert to lower levels in 2026 unless Congress acts to make them permanent.
State-Specific Estate and Inheritance Tax Considerations
State tax laws concerning property transfers at death vary significantly, adding a layer of complexity beyond federal considerations. Some states impose their own estate tax, which is similar to the federal estate tax but often with different exemption thresholds. As of 2025, about 12 states and the District of Columbia assess an estate tax. These state estate taxes are typically imposed on the total value of the deceased’s estate before distribution to heirs.
Other states levy an inheritance tax, which is paid by the beneficiary receiving the assets, not by the estate. These taxes often depend on the beneficiary’s relationship to the deceased and the value of the inherited property. In 2025, states like Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania have an inheritance tax, though Iowa phased out its inheritance tax as of January 1, 2025. Many states, however, have neither an estate nor an inheritance tax.
Property transferred via a TODD is generally not exempt from these state-level taxes if they are otherwise applicable. The TODD primarily facilitates the transfer of ownership outside of probate; it does not automatically shield the property from state estate or inheritance taxes. For example, Maryland is unique in that it levies both an estate tax and an inheritance tax. Researching the specific laws of the state where the property is located and where the deceased resided is crucial to understand potential state tax liabilities.
Capital Gains Tax and Basis
A significant advantage of receiving property through a Transfer on Death Deed is the “step-up in basis” for the beneficiary. Basis refers to the original cost of an asset, which is used to calculate profit or loss when the asset is eventually sold. With a step-up in basis, the property’s value is generally reset to its fair market value on the date of the original owner’s death.
This adjustment can substantially reduce or even eliminate capital gains tax if the beneficiary sells the property shortly after inheriting it. For example, if a property was purchased for $100,000 and is worth $500,000 at the owner’s death, the beneficiary’s basis becomes $500,000. If they sell it for $510,000, capital gains tax would only be owed on the $10,000 appreciation since the death, rather than the $410,000 appreciation from the original purchase price.
This is a notable distinction from receiving property as a lifetime gift, where the recipient generally takes on the donor’s original basis, potentially leading to a higher capital gains tax if the property has appreciated significantly.
Property Tax Considerations
A Transfer on Death Deed does not eliminate the ongoing obligation to pay property taxes. The property remains subject to annual property taxes, just like any other real estate. Recording a TODD itself typically does not trigger a property tax reassessment or a transfer tax at the time the deed is filed. This is because the actual transfer of ownership only takes effect upon the death of the grantor.
Upon the grantor’s death and the subsequent transfer of ownership to the beneficiary, some states or localities may reassess the property for tax purposes. This reassessment would reset the property’s taxable value to its current fair market value, potentially resulting in higher annual property tax bills for the new owner.
While some jurisdictions offer exclusions from reassessment for transfers between specific family members, these rules can be complex and vary. Beneficiaries should consult local tax authorities to understand how a change in ownership through a TODD might affect their property tax obligations.