Ok, so a family friend is selling his house to me at a very cheap price. You could call it a gift of sorts. He is moving will no longer need the property, I am working full time and going to school to finish a degree. Recently the bank discharged his mortgage and literally gave him the house free and clear. The only money owed on the house is the back taxes. Our agreement is that I pay the back taxes and pay off the remaining balance from his discharged bankruptcy and the house is mine.
I went to a closing agency this week and they tried to tell me that if we do not transfer the house for a "reasonable market value" that the state will come after me for the full tax assessment value on the house. Is this true that a state (PA) can reject a legitimate sales price of a property? Should I consult a different closing agency? Instead of an agency should I use an attorney? I'll be paying cash for the house.

Sounds like he is trying to get out of a lot of money owed. No one buys a property for back taxes only. You only 'have to pay his back taxes and the remaining balance from his discharged bankruptcy! '

And what is the entire amount, what shape is the house in..

Run the other way !

You will end up with "gift" taxes, on the difference between reasonable value and actual value paid.

also a bank does not "give you title" they will show a property is paid for in full.
There will be a signed and stamped copy showing the mortgage paid off.

If a bankruptcy is discharged, then there is no debts owed from it? That is confusing as to what you are to pay and to whom?

The state wants full tax value, they will want you to pay the proper transfer tax on the property.
In additional, the IRS will consider the difference a gift and taxes will be owed on that also.

You need a attorney, not closing agency to handle this sale.
Also it is a sale, not just a transfer. The incorrect use of terms can make the transaction appear differently.

Get a lawyer and end this confusion.

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Our agreement is that I pay the back taxes and pay off the remaining balance from his discharged bankruptcy and the house is mine.

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If he was discharged in bankruptcy, he doesn't owe such debt(s). The bank which had the mortgage could have sold the house in satisfaction of the amount owed, but you indicate that the bank "discharged" the mortgage, so it is unclear what you mean.

If property taxes are owed on the house, it appears that you would have to pay those. And, as others have noted, you would still have to pay the transfer tax on the full value of the house. Apparently you and the state disagree on the value. And, as also noted, you will probably be liable for gift tax.

I agree, you need an attorney to help you with this.

To answer your question, yes, a sale has to be at market value otherwise it becomes a gift. On the other hand, your friend can give you a mortgage for the difference between fair market value and what you are paying, then gift it to you a little each year (I think the current max gift is $18K).

You need a real estate attorney to manage this sale.

Thanks for the advice. I'll be contacting an attorney. Btw, the house is in good condition. I've been living in it for about 6 months and it has a new roof. The only thing wrong is it needs to be painted cause he never did, and I want to install natural gas heat. But the oil heater works. He is a very good friend of the family for those who do not understand.
And yes, the bank signed over the house. I saw the transfer of the deed in addition to the tax form they sent him this past month for it.

Regarding the federal gift tax, the annual exclusion amount is currently $14,000.

I'm sure you are getting a good deal, here. But as noted, a transfer at less than market rate can be considered a gift. So it would be better to buy it at market rate and have him forgive $14K of the balance each year.

I would still have a title company confirm that he has clear title.

Clarification on the gift tax comments - it's not the OP who has an issue with gift taxes, but his brother who is making the gift, because it's the giver who may owe gift taxes, not the receiver. As noted, the exclusion is currently $14K per year - if gifts are made from one individual to another within a tax year that exceed that amount they must be documented on a Gift Tax form when income taxes are filed. But it is highly unlikely that any gift tax is actually due - no tax is actually payable until the sum of gifts above the annual exclusion made throughout a person's lifetime exceeds the lifetime exclusion, which is currently $5.34 million. It seems unlikely that that's an issue in this case.

While I agree about the gift taxes, there are other issues That might be triggered in a real estate transfer at less than market value.