What Is Escrow And How Does It Work? Escrow And Taxes

Part VI of a series on the escrow process. Thank you to Kartikay Escrow for contributing portions of this blog.
You know what they say about taxes . . . . This truism remains especially true when dealing with the sale or purchase of a home. You know you’ll have to pay taxes on the home, but what kind? And to whom? And when?

First, we’ll need to file with the appropriate local agencies before we notify the IRS. Below, we explain how the process works.

Change of Ownerships Filings

When property changes hands, local government agencies require notice of change of ownership. At the local level, this would be any county office that assesses or collects taxes. Reporting a change in the ownership of the property allows the local jurisdiction to assess the tax liability for each property as the title is transferred from seller to buyer.

The reporting documents vary from state to state, but all states require at minimum the names of the seller and buyer, assessor’s parcel number or other property identifying number, the property location and tax address. Also required is the total purchase price, terms of sale and signature of the new owner. The reporting document is recorded along with documents evidencing a change in ownership. In California is called a Preliminary Change of Ownership (PCOR), and it assists the local agency in identifying situations in which a property reassessment is allowed under Proposition 13.

Penalties or fines may be assessed from the governing body for failure to file the document as required by state or local laws.

Federal Requirements

The Internal Revenue Service (IRS) requires that sellers report certain information pertaining to sales of real property. Reportable transactions include sales and exchanges of properties, including, but not limited to, houses, townhouses, condominiums, cooperative housing corporations, and mobile homes without wheels. Specifically excluded from reporting are foreclosures and abandonment of real property as well as financing or refinancing of properties.

The escrow officer, as the settlement agent, will ask the seller to complete a Certificate for Information Reporting for the 1099-S form which may be required by the IRS. The seller is required to provide his or her correct taxpayer identification number (social security number), as well as the closing date of the transaction and gross proceeds of the transaction. Most settlement agents now transmit the reportable information electronically to the IRS at the end of the year, although a “hard copy” of the form is included in the seller’s closing documents.