It's Just a Deed, Isn't It Simple?

Posted on October 15, 2020

Originally published in October 2020

This article has not been updated for current law since the date of its posting on the website. This article is not intended to provide any legal advice. Please seek advice of your professional council.

Any U.S. federal and state tax advice contained in this communication is not intended or written by the Knox Law Firm to be used, and cannot be used by you, for the purpose of: (i) avoiding penalties under the Internal Revenue Code that may be imposed upon you, or (ii) promoting, marketing, or recommending to another party any transaction or matter addressed herein.

Types of Deeds

General Warranty Deed: Provides the highest level of protection to a buyer. The seller warrants, or promises, to defend against claims against the property "generally." The seller is warranting legal title to the property, and is warranting that the property is free and clear of liens, debts, encumbrances, etc., now and from all previous owners. Although this type of deed is ideal from the buyer's perspective, sellers will be reluctant to warrant title to the property for a period they did not own it.
Special Warranty Deed: Provides the second highest level of protection to a buyer. The seller warrants to defend against claims against the property "specially." The seller is warranting legal title to the property, and is warranting that the property is free and clear of liens, debts, encumbrances, etc. during the period of the seller's ownership only. This is the most common type of deed used in Pennsylvania. It is more palatable to sellers since the risk is knowable, since it only covers the time they owned the property.
Quitclaim Deed: Provides the lowest level of protection to a buyer. The seller is not warranting anything. It only transfers any interest the seller might have in the property. Essentially, it says, "If the seller owns this property, seller is transferring it to buyer." In an arm's length transaction, this is typically not adequate. However; if, for example, a mother and father wish to transfer real estate to a child, this would be the easiest way to accomplish it and is very commonly used for these types of transfers. Another example of when quit claim deeds are useful is when someone gets married and wants to add their spouse to the deed.

*NOTE: For more information on transferring real estate to children, and why that may not be a good idea, see both our Elder Law FAQs and the article: Transferring Assets: In Trust or to Children?

Fiduciary Deed: A special type of deed used by fiduciaries such as executors, guardians and trustees. It is typically akin to a special warranty deed, but usually only to the extent of the fiduciary's knowledge. The exact language used in the deed will control the level of warranty being granted. These are commonly used in Pennsylvania, but buyers need to carefully review title before accepting a fiduciary deed.

Potential Pitfalls When Transferring Real Property

Unpaid Inheritance Tax
Unsatisfied Mortgages, Other Liens and Judgments Against Seller
Restrictions Affecting the Use of the Property
Rights of First Refusal

Unpaid Inheritance Tax

The rate of inheritance tax which must be paid on PA real property is based on the relationship between the beneficiary and the decedent:

0% to spouses and charities
4.5% to lineal heirs (children)
12% to siblings
15% to everyone else

If inheritance tax is not paid on the property after the owner's death, it is a lien which attaches to the property. The lien lasts for 20 years if the property has been transferred to an unrelated third party for good and valuable consideration. If the property has been transferred to a related person, the lien lasts until the tax is paid.

When buying from an estate, you need to examine the inheritance tax return to make sure the property was listed as an asset at its fair market value (i.e. either the sale price to a third party, the price provided by a third party appraisal, or its tax assessed value multiplied by the common level ratio). Common level ratios (CLR) are meant to adjust the tax assessed values to fair market value. CLRs greater than 1.0 denote the tax assessed values in that particular county are generally lower than fair market value, whereas CLRs less than 1.0 denote tax assessed values in that particular county are generally greater than fair market value.

Currently, the CLR for Erie County is 1.16. This means that if the assessed value for a piece of property is $100,000, the fair market value is $116,000 ($100,000 * 1.16).

If a buyer wishes to purchase a property from an estate which has not been settled yet, an inheritance tax escrow should be held. Title companies generally compute the escrow as an amount equal to the fair market value multiplied by the rate of applicable tax multiplied by 1.5

For example, if the property is worth $116,000 and was left to lineal heirs, the property tax escrow should be $7,830 ($116,000 * 4.5% * 1.5).

Once the inheritance tax return is filed and an appraisement notice has been received from the Pennsylvania Department of Revenue stating that the return has been accepted as filed, the escrow can be distributed to the seller's estate.

If the decedent transferred property during his or her lifetime, but retained a life estate, that is taxable as well. Federal estate tax liens are valid for ten years from the date of death.

Unsatisfied Mortgages, Other Liens and Judgments Against the Seller

Especially since most buyers will receive a Special Warranty Deed, it is critical to have a title search done to determine if there are any unsatisfied mortgages or liens on the property.

Unsatisfied mortgages must be satisfied, as they represent a cloud on title. There is a presumption of payment twenty years after maturity, but the presumption can be rebutted.
Child support liens have a twenty year statute of limitations, which begins after the last payment was due.
Municipal liens have a twenty year duration and affect the property that received the service. This is why water/sewer escrows are routinely collected at closing.
Pennsylvania criminal liens are indefinite in duration. Federal criminal judgments last for the later of (i) twenty years, or (ii) twenty years from when the person fined is released from prison or dies.
Department of Revenue liens and Pennsylvania Department of Labor and Industry Unemployment Compensation liens are indefinite in duration. This is the purpose of obtaining a corporate lien certificate for corporation and LLC sellers.
Real estate tax liens have a twenty year statute of limitations.
Homeowners/Condo Association liens, mechanics’ liens, and commercial real estate brokers liens are extinguished after five years, unless revived.
Pennsylvania sales and use tax liens have a five year duration
General judgments in Pennsylvania Common Pleas Court and non-governmental federal civil court claims are extinguished after five years.
Civil judgments in Federal court in favor of the United States (except for Federal tax liens) last for twenty years.
Federal IRS liens last for ten years and thirty days from the date of assessment.

Restrictions Affecting the Use of the Property

Restrictions might be contained in previous deeds or in other documents affecting the entire community (condos, home owner associations, etc.). Either way, if properly drafted and recorded, the restrictions “run with the land” meaning all new owners will be bound by them.

Examples include:

Height restrictions
Vehicle restrictions
Fencing specifications
Tree removal
Approval of renovation, additions, or new structures
Yard signs
Adjacent structures (sheds, garages, pools, etc.)
Prohibition on business activities
Pet restrictions

Rights of First Refusal

A right of first refusal (ROFR) can take many forms, but the main concept is to grant a right to a person or entity to have the first opportunity to purchase property upon the owner's decision to sell at the same terms offered by a third party or at predetermined terms. As with all of the other issues discussed, without searching the title, a ROFR could exist without the buyer knowing it.

Typical issues which may arise:

What property is covered? Are there adjoining parcels which are also affected?
What triggers the ROFR? Are transfers to family members included, for example?
What does “same terms” really mean? If the owner is willing to provide seller financing to a prospective buyer, do they have to offer that to the holder of the ROFR?
What is the duration if it is not specifically included? Does the right exist every time the owner attempts to sell the property or just the first time?

From the perspective of a potential buyer, if a ROFR exists on the property, at the very least closing will take longer than normal. Depending on the complexity, it could effectively make the property impossible to purchase.

How to Guard Against Pitfalls

Title Search

A title search is a detailed examination of the historical records concerning a property. These records include deeds, court records, property and name indexes, and many other documents. The purpose of the search is to verify the seller’s right to transfer ownership, and to discover any claims, defects and other rights or burdens on the property.

Title searches must go back at least sixty years in the chain of title. If title has been held by related parties for more than sixty years, the search must go back to a valid transfer between unrelated parties for valuable consideration.

There are some “hidden hazards” that even the most diligent title search may never reveal. For instance, the previous owner could have incorrectly stated his marital status, resulting in a possible claim by his legal spouse. Other “hidden hazards” include fraud and forgery, defective deeds, mental incompetence, confusion due to similar or identical names, unpaid judgments and liens not of record, and clerical errors in the records.

Title Insurance

All banks require a title policy (a lender’s policy) to be purchased for their benefit to protect their position as the holder of a lien against the property. If the owner of the property doesn’t pay the bank loan, the bank is guaranteed that they are paid first if the property is foreclosed on and sold at auction. Title insurance guarantees this by providing assurance to the bank they are in the first lien position.

In addition to a lender’s policy, buyers should consider an owner’s policy as well. Both policies insure the same things; the difference is simply the beneficiary of the policy. It costs very little to buy the owner’s policy if a lender’s policy is already required.

Title insurance is designed to protect against covered title defects that existed prior to the issue date of the policy. If a valid claim is filed, policy, subject to its terms and conditions, will cover financial loss up to the face amount of the policy.

Author: Frances A. McCormick

Originally published in October 2020