Inheriting a Property in Pennsylvania. That state has some unusual rules that directly affect our regular advice on this topic.
By Ilyce Glink and Samuel J. Tamkin
Q: I have an elderly sister in Pennsylvania who owns her home. It is worth around $70,000.
She’s in poor health and my younger sister is named in the will as beneficiary to that house.
Is there any way for my younger sister to avoid federal and/or state taxes as she inherits the house?
Would it be wise to have my younger sister added to the deed to be co-owner? In the event of my older sister’s death, could the house be sold (by the executor, perhaps?) and the proceeds go to my younger sister, minus any taxes or costs of sale?
Inheriting Property and Estate Taxes
A: Thank you for your question. Which is a variation on one of the most popular issues we hear about – inheriting property.
Let’s get a couple of items out of the way. First, the vast majority of Americans don’t have to worry about estate taxes. As far as the federal government is concerned, when a person dies, that person’s estate won’t have to pay any estate taxes if the value of the estate is less than $12,060,000 (according to irs.gov) and the death occurs in 2022. Many states have no estate tax at all. While others may start charging an estate tax at $1 million (Massachusetts’ state estate tax begins at that level, according to www.mass.gov).
Inheritance Tax in Pennsylvania
However, your elderly sister lives in Pennsylvania. That state has some unusual rules that directly affect our regular advice on this topic.
All real property (like a house), tangible personal property (including cars, cash, and furniture) and intangible property (like stocks and bonds) are subject to inheritance tax in Pennsylvania. There is no exclusion, except between spouses and parents to minor children. So, a spouse can pass ownership of all real and personal property to a spouse (or a minor child under the age of 21) upon death without paying tax, but siblings cannot.
The amount of tax paid is based on the relationship to the decedent. “The tax rate for Pennsylvania Inheritance Tax is 4.5 percent for transfers to direct descendants (lineal heirs), 12 percent for transfers to siblings, and 15 percent for transfers to other heirs (except charitable organizations, exempt institutions, and government entities that are exempt from tax),” according to the Montgomery County, Pa. website.
Our initial thought was to add your younger sister to the older sister’s deed. But even joint tenants with rights of survivorship are subject to the inheritance tax.
Gifting a Property
What about a gift? Turns out, Pennsylvania doesn’t have a gift tax. Your sister could give the entire property to her younger sibling now, while she is alive. There should be no estate or gift tax consequences. While the federal annual gift tax exemption for 2022 is $16,000, the lifetime gift amount is $12.06 million.
If your sister is worried about transferring ownership, she could maintain a life estate for the property, which would allow her to live there as long as she wants.
There are other options – but gifting the property should be an easy way to pass the property to your younger sister without paying estate tax. An attorney can help you with the paperwork, or you may even be able to execute a quit claim deed and file it with the local recorder of deeds office.
Capital Gains Tax
Bear in mind that if your older sister gifts the property now to the younger sister. There may well be capital gains tax to pay down the line. That’s because when your older sister gifts her the property, your younger sister will receive it at the price the older sister paid for the house (known as the basis). This might cause a taxable event, and it’s the reason we rarely prefer this method of transfer compared with an inheritance.
For example, if your older sister paid $20,000 for the property and it’s worth $70,000 today, your younger sister will receive the property at its $20,000 cost basis. When she sells the property, she’ll have to pay long-term capital gains tax on the $50,000. (She will be able to subtract the costs of sale and any material work that is done to the property under her ownership.)
Depending on your younger sister’s income, the capital gains tax owed might be less than 12 percent. If she decides to live in the property and doesn’t sell it, or if she decides to rent it out, at least she won’t owe the 12 percent inheritance tax within nine months of her sibling’s death or pay capital gains tax, but there could be other tax issues to consider.
Complex Matter Consult a Estate Attorney
There’s a good deal of complexity in what seems to be a simple request. Before making any moves, your older and younger siblings should consult with an estate attorney and their tax preparer.
©2022 by Ilyce Glink and Samuel J. Tamkin.