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Pennsylvania is one of six states that has an inheritance tax. The tax is paid on specific inheritances that are disbursed to the heirs. However, Pennsylvania does not have an estate tax, so property inherited by a joint owner is not taxed. If you do have to pay an inheritance tax, the tax ranges from 4.5 to 15 percent. Children and lineal heirs pay 4.5 percent. Siblings pay 12 percent. Other heirs, except for charitable organizations, exempt institutions and government entities pay 15 percent.
The inheritance tax makes it difficult for someone other than your spouse to inherit your property, especially if there is not enough equity to pay the tax. If the property is something you want your heir to keep, they may not be able to keep it if she can’t pay the taxes.
How the Inheritance Tax Affects the Sale of Property
When you sell property, you hope to get as much out of it as possible. However, closing costs and taxes could take a huge chunk out of your equity. One of those taxes is the inheritance tax. While this doesn’t affect most people, it does affect those who were not related to the decedent, especially if the property has very little equity in it.
If you inherit a property that is worth $500,000 and you are not related to the decedent, and the property has a relatively new mortgage on it, you’re not going to get much out of the property. If the current mortgage balance is $450,000, the payoff is always a bit higher – usually a few thousand, to account for the per diem interest rate and any charges the lender tacks on to processing the payoff. That leaves $50,000.
You now have to subtract the seller’s closing costs and your real estate agent’s commission. That could be $30,000 or higher. Using the $30,000 amount, that now leaves you with $20,000. Now, you have to pay the inheritance tax out of that – on $500,000 at 15 percent, that is $75,000. You are now $55,000 in the hole for a property you inherited.
Using the same example, a sibling who inherited the property would have a $60,000 tax obligation, which would put him or her $40,000 in the hole.
Avoiding the Tax
The only way to avoid the tax is to give your heirs “gifts” throughout the years. The amount you can gift changes every year. For 2019, the most you can give one person during the year is $15,000 without having to pay federal taxes. If you give the amount of the inheritance taxes to the person inheriting your real estate throughout the years, you can offset the inheritance tax. However, the heir must still pay the tax. they must save the “gift” you give them every year.
The other option would be to pay down the mortgage as much as possible so that the heirs have more equity to cover the estate tax. If you own real estate in Pennsylvania and plan to include it in your will to someone other than your spouse, speak with a tax professional about the inheritance tax and other taxes that become due on your estate after your death.
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