That house on the Cape, Martha's Vineyard, or in the Berkshires, what happens when the owner dies and is not a Massachusetts resident? Is it subject to the Massachusetts estate tax?
And it's a bit complicated.
Massachusetts is one of the few remaining states with an estate tax and it ties Oregon with the lowest threshold at $1 million (read Does Your State Have Estate or Inheritance Taxes?). For the most part, it applies only to the estates of people who were Massachusetts residents when they died, but it also applies to Massachusetts real estate of non-residents. On the other hand, Massachusetts does not tax non-Massachusetts real estate of Massachusetts decedents.
The tax is calculated based on the percentage of the entire estate represented by the Massachusetts real estate. For instance, let's assume the decedent's estate totaled $1.5 million of which his Massachusetts property accounted for $400,000. The Massachusetts estate tax on a $1.5 million estate is about $70,000 (download A Primer on the Massachusetts Estate Tax for more specifics). Since the Massachusetts property accounts for about 27% of the total estate, the tax due in this case would be about $19,000 ($70,000 x .27 = $18,900).
If, on the other hand, the decedent's entire estate totaled $900,000, while the house would make up a larger portion of it -- 44% -- there would be no estate tax due because the entire estate is under the $1 million threshold for Massachusetts taxation.
How to Avoid the Tax
It's actually more difficult to avoid this tax than some others because simply transferring the property to trust doesn't work. It does, however, work to transfer the property to a limited liability corporation or partnership. That's because doing so changes the character of the ownership from real estate to shares of stock in a corporation or interest in a partnership. Massachusetts does not tax non-real estate property of non-resident decedents, even if the corporation or partnership is based in the Commonwealth.
The question is whether the expense of creating and maintaining the LLC or LLP, including annual reports and tax returns, justifies the ultimate tax savings. In our example above, with an ultimate cost of $19,000, the answer is probably no; you're better off simply paying the estate tax. But with a larger estate and a more expensive property, the calculation may be somewhat different.
Another option is to give the property away during life so that it's not in your estate when you die. This can also simplify things for your heirs. Not only do they avoid Massachusetts taxation, but they also avoid Massachusetts probate (though the latter can also be accomplished through the use of a trust). The problem with such transfers is that they can result in your heirs having to pay a tax on capital gains should they sell the property that far exceeds the Massachusetts estate tax liability. This depends on how much the property has appreciated in value since you acquired it and whether your heirs are or are not likely to sell it. A vacation house that stays in the family from generation to generation will not incur a tax on capital gains.
In short, the estate tax on Massachusetts real estate owned by non-resident decedents is difficult, but not necessarily impossible, to avoid. In each case, owners with their attorneys, accountants, and families must determine whether it make sense to take any of the planning steps available.
View our webinar, A Primer on Massachusetts Estate Tax