Are You Required To Pay Estate Tax on Real Estate You Inherit?

How Much Is Inheritance Tax

How much is inheritance tax? The amount of tax you pay on your inheritance varies depending on the state where the deceased person lived and the value of the inheritance. Note that, as of 2022, only six states in the US have an inheritance tax.

In general, inheritance tax is calculated as a percentage of the value of the inheritance. The exact rate of the tax will depend on various factors, including the size of the inheritance, the relationship of the beneficiaries to the deceased person, and any applicable deductions or exemptions. This rate can range from single digits to anywhere around 15% to 18%.

Applicable deductions increase with the closeness of the beneficiary to the deceased. Surviving spouses, for example, don’t have to pay any inheritance tax in all six states. In New Jersey, domestic partners are also exempt from inheritance tax. In other states like Iowa, Kentucky, Maryland, and New Jersey, descendants are not taxed on their inheritance.

Note, however, that inheritance tax only applies when the inheritance exceeds a certain threshold set by the state. In Iowa, for example, inheritance tax is only charged on inherited estates that exceed $25,000. In Maryland, the threshold is $55,000.

Inheritance Tax Exemptions For Heirs And Beneficiaries By State

As mentioned earlier, different states have different thresholds and exemptions on inheritance tax, depending on the closeness of the beneficiary to the deceased. Below are some of the exemptions by all six states that charge tax on inheritance:

1. Kentucky: Spouses, children, parents, and siblings are exempt from inheritance tax in Kentucky. Other beneficiaries also do not have to pay inheritance tax on estates worth less than $500 or $1,000, depending on the circumstances. Inheritance tax percentages can range from 4 to 16%.
2. Nebraska: Parents, children, grandparents, grandchildren, and siblings have to pay inheritance tax on inherited estates of more than $40,000. This threshold is expected to rise to $100,000 in 2023. Charities and spouses are fully exempt. Unrelated beneficiaries will pay inheritance tax on amounts of estates beyond $10,000, which will rise to $25,000 in 2023. Other relatives such as uncles, aunties, nephews, nieces, and cousins are exempt up to $15,000, which increases to $40,000 in 2023.
3. Iowa: Spouses, lineal ascendants, and lineal descendants are fully exempt from inheritance tax. Charities, however, are only exempt up to $500. Tax rates range from 3 to 9% on others.
4. Maryland: Charities and immediate family members such as spouses, children, parents, siblings, grandparents, and grandchildren are fully exempt. However, there is an exemption threshold of $1,000 on other unrelated beneficiaries with rates up to 10%.
5. Pennsylvania: Inheritance tax rates in Pennsylvania are 4.5%, 12%, and 15% on estates willed to adult children, parents, grandparents, grandchildren, and other beneficiaries, with a threshold of $3,500. Only spouses and minor children are exempt.
6. New Jersey: Charities and immediate family members are fully exempt. Other relatives, including inlaws, are exempt up to $25,000. Inheritance tax rates can go from 11% to 16%, depending on the closeness to the deceased.

Suppose you are an estate beneficiary and concerned about inheritance tax. In that case, it is recommended that you consult with a tax professional or an attorney who can provide guidance on the specific tax rules and regulations in your state.

Do Beneficiaries Pay Inheritance Tax?

Except if the deceased is from the six states mentioned above, including Iowa, Kentucky, New Jersey, Pennsylvania, Nebraska, and Maryland, you don’t have to worry about inheritance tax. If the deceased is from any other state, they only have to pay an estate tax, and beneficiaries don’t get to pay anything on the estates they inherit after that. 

Also, as mentioned above, not every beneficiary pays the inheritance tax, even in the mentioned states. Each of those six states has a standard for calculating inheritance tax based on the relationship between the beneficiary and the deceased.

How To Avoid Inheritance Tax

Inheritance tax can be avoided only before the death of the testator. Below are some ways you can avoid inheritance tax for your beneficiaries.

1. Write your will and name your beneficiaries. Failure to do this will warrant the state to distribute your assets to heirs and relatives based on the state’s intestacy rules. Once this is done, heirs and beneficiaries must pay tax on their inheritance.
2. Gift your assets to beneficiaries beforehand. This is because gifts are not taxed in 49 states of the US, except for Connecticut. 
3. Give your assets to charity. When you list a charitable organization as a beneficiary, they are not required to pay inheritance tax.
4. Depending on the state you live in, will your estate to close family relatives, especially spouses and children. In some states, relatives like grandparents, grandchildren, siblings, and parents don’t have to pay inheritance tax.
5. Don’t go beyond the inheritance tax threshold: Every state has a threshold to which inheritance tax is charged. Understand your state’s inheritance tax threshold and try to keep the inheritance below it.
6. Put your assets in a trust: In all 50 US states, assets that are kept in a trust are not considered part of your estate.a

Do You Qualify For An Exclusion on an Inherited property?

The answer is usually no. However, there are stepped-up basic rules for inheriting real estate which you may benefit from. You may not need an exclusion at all when you sell an inherited home or property. 

What Heirs Benefit From The Home Sale Tax Exclusion?

The home sale tax exclusion law is meant to provide homeowners with a generous tax exclusion when the property is sold. The tax law provides homeowners for up to $250,000 in profit exclusion from a home and up to $500,000 tax exclusion for married couples.

How Do I Make Sure I Qualify For A Home Tax Exclusion?

In order to qualify for the tax exclusion, the home must have been used as the main home for two years out of the prior five years before the sale. 

Essentially, if you are looking to sell the home as soon as you inherit the property, you will not qualify for this exclusion. You would have to live in the home for at least two years to qualify.  

Again though, you might not actually need the exclusion because of the stepped-up basis rules. If you have specific questions about these laws, you should consult an attorney in your state or a probate tax attorney.