You Left Massachusetts – Your Real Estate Didn’t

Massachusetts quietly amended its estate tax statute last summer. This amendment significantly changes how the tax is calculated for non-resident decedents owning Massachusetts real estate. This is good news. But it comes with an important catch for non-residents owning higher-value Massachusetts real estate (i.e., real estate having an equity value greater than $2 million). For now, as discussed below, a simple planning strategy should provide a solution to avoid a non-resident estate tax and return filing requirement.

As background, Massachusetts imposes a non-resident estate tax on real estate and tangible personal property located in the state. Moving out of state provides no protection to this in-state property. Until last summer, the tax was calculated using the decedent’s worldwide assets as the starting tax base. Under the new law, the tax is now based only on a person’s Massachusetts real estate and tangible personal property, which has dramatically reduced the tax exposure for non-residents. For example, suppose a Florida resident dies with a $23 million estate, including a $3 million Truro vacation home. This non-resident would have owed a $310,742 Massachusetts estate tax. Under the amended law, the Massachusetts tax would now be $82,400.

Non-residents whose Massachusetts homes are under the Massachusetts $2 million exemption are not necessarily fully protected. This is where many practitioners get tripped up. Even when no Massachusetts estate tax is owed, a return filing is typically still required because the filing threshold is based on all assets owned, regardless of location, and adjusted taxable gifts made. This means a nonresident with a modest Massachusetts cottage and a large out-of-state retirement account or investment portfolio may still owe a filing, and still face a lien, even if no Massachusetts tax is ultimately due. And a return filing, along with the costs associated with its preparation, will be required to release the automatic lien placed on the real estate upon death. Absent this release, the real estate will be subject to a cloud on title.

Short of transferring the Massachusetts property prior to death, one solution to avoid any tax or return filing requirement is to hold the property in a limited liability company. Transferring real estate to an LLC during life converts the real estate interest into an intangible asset (i.e., a membership interest), removing it from the Massachusetts tax base for non-residents. Quite simply, the tax exposure and tax filing requirement disappear. Let’s assume the Florida decedent noted above instead transfers the Massachusetts property to an LLC during life. The result would be the full elimination of the $82,400 and avoidance of any estate tax return filing requirement (and hence no real estate lien issues).

One question practitioners sometimes raise is whether an LLC formed solely to hold real estate would be disregarded for estate tax purposes for lacking a business purpose. The short answer is no. The Massachusetts estate tax statute does not impose a business purpose requirement. It turns on the character of the asset, not the motive for holding it. A membership interest in a Massachusetts LLC is intangible personal property as a matter of statutory law. The argument that an LLC should be collapsed because it was formed for tax planning purposes conflates the business purpose rule in creditor protection analysis with a separate and distinct question about asset classification for estate tax purposes. These are different legal frameworks and the distinction matters.

In my view, this is a straightforward application of existing law, not aggressive or speculative planning. While several other states have closed this planning opportunity by explicitly treating LLC interests as look-through assets for estate tax purposes, Massachusetts has not. Until it does, nonresident property owners are entitled to plan under the law as written. If Massachusetts ultimately changes the law, the worst outcome is returning to where you are today with the only cost being modest formation and annual report filing fees.

Importantly, this works in one direction only. Placing out-of-state property in an LLC may have the opposite effect by converting excluded real estate into an intangible interest that could be pulled into the Massachusetts taxable base. The direction matters.

If you own Massachusetts real estate and live out of state, now is the time to review your plan before stubbing your family’s toe on an unnecessary estate tax.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.