Understanding Pennsylvania Inheritance Tax
Pennsylvania’s inheritance tax can significantly impact estates with notable real estate holdings. Real estate is included in the taxable estate, and the tax rate varies depending on the beneficiary’s relationship to the deceased. According to the Pennsylvania Department of Revenue, the rates are:
Unlike the federal estate tax, Pennsylvania’s tax has no large exemption amount that shelters most estates. A home or rental property left to adult children is taxed at 4.5% of its value, and the same property left to a niece, nephew, or friend is taxed at 15%.
Which Real Estate Is Taxed
The Department of Revenue explains that all real and tangible personal property of a Pennsylvania resident located in Pennsylvania at death is taxable. For a person who lived outside Pennsylvania, real and tangible property located in Pennsylvania is still taxable here. In other words, the location of the land matters: a vacation home in Pennsylvania owned by an out-of-state resident can trigger a Pennsylvania return, and property in another state may be subject to that state’s rules instead.
Debts the decedent owed at death, costs of administering the estate, and funeral and burial expenses are deductible against the taxable estate. A mortgage on the property, for example, reduces the value subject to tax.
Strategies for Reducing Inheritance Tax
Proactive estate planning is essential to minimize the impact of inheritance tax. Here are some strategic approaches, along with the Pennsylvania rules that limit each one:
1. Gift Your Property
One way to lessen the value of property included in an estate is by gifting it during your lifetime. Under the Pennsylvania inheritance tax law (72 P.S. § 9107(c)(3)), a gift made within one year of death is pulled back into the estate and taxed to the extent the gifts to that recipient exceed $3,000 in a calendar year. Gifts made more than a year before death are generally not taxed unless you kept the right to use the property, as explained below. Federal gift tax reporting rules may also apply, and a gift can carry different federal income tax consequences for the recipient than an inheritance, so the timing and form of a gift should be weighed carefully.
2. Establish a Qualified Personal Residence Trust (QPRT)
A QPRT allows you to transfer your personal residence to a trust while retaining the right to live there for a specified number of years. For federal gift tax purposes, the gift is valued at less than the home’s full market value because of the years you keep. Pennsylvania treats retained interests differently. Under 72 P.S. § 9107(c)(5), a transfer is taxed if you keep possession or enjoyment of the property for life or for any period that does not in fact end before your death. A QPRT can therefore help with Pennsylvania inheritance tax only if you outlive the trust term, and choosing that term is an important part of the planning.
3. Consider Joint Ownership
Holding property jointly with rights of survivorship allows a smooth transfer upon the first owner’s death, often without needing to pass through probate. The inheritance tax result depends on who the co-owners are:
Adding a child to a deed can reduce the share that is taxed later, but it also gives that child an ownership interest now, which can expose the property to the child’s creditors or a divorce and can make a later sale or refinance harder.
4. Make Use of Life Insurance
Life insurance policies can provide liquid assets to heirs, which can be earmarked to pay the inheritance tax so that real estate does not have to be sold quickly. Under 72 P.S. § 9111(d), all proceeds of insurance on the life of the decedent are exempt from Pennsylvania inheritance tax. Whether the policy should be owned by an irrevocable trust is mainly a federal estate tax question for larger estates.
5. Look at the Farmland and Family Business Exemptions
Pennsylvania exempts certain agricultural real estate from inheritance tax for decedents who died after June 30, 2012. According to the Department of Revenue, to qualify for the “business of agriculture” exemption the real estate must be devoted to agriculture at the time of death, pass to “members of the same family” (or a trust solely for their benefit), stay devoted to agriculture for seven years after death, produce at least $2,000 a year in agricultural gross income during those seven years, and be reported on a timely filed inheritance tax return. Each new owner must file an annual certification for the seven-year period.
A separate exemption covers a qualified family-owned business interest with fewer than 50 full-time equivalent employees, a net book value of assets under $5 million, and at least five years in existence at the date of death. The business’s principal purpose cannot be managing investments or income-producing assets, so an entity that simply holds rental property generally will not qualify. Property moved into the business within one year of death is not covered unless the transfer had a legitimate business purpose.
6. Plan for the Deadline and the Early-Payment Discount
Pennsylvania inheritance tax is due at death and becomes delinquent nine months after the date of death. If the tax is paid within three months of death, a 5% discount applies. Because real estate is often the largest and least liquid asset in an estate, planning ahead for how the tax will be paid, whether through life insurance, other liquid assets, or a planned sale, can help an estate take advantage of the discount and avoid a forced sale.
Why Engaging a Professional Matters
Inheritance tax planning is complex, especially for those with substantial real estate holdings. Working with an estate planning attorney and your financial advisor can help you build a strategy that reflects current law and your family’s unique situation. Several of the rules above turn on timing, such as the one-year lookback for gifts and new joint accounts, so it helps to plan well before a transfer is needed.
Related Reading
This article is general information about Pennsylvania inheritance tax, not legal or tax advice for your situation. Speak with an attorney about how these rules apply to your property and family.
