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Washington state changes to estate tax apportionment for real estate owned by a business entity

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The Washington State Department of Revenue (“DOR”) recently announced a change in the way they will treat real property owned by business entities, including partnerships and LLCs, for estate tax purposes. The new ruling went into effect on June 1, 2020 and impacts both residents who own out-of-state property as well non-residents who own real property in the state of Washington.

Washington Estate Tax Application and Apportionment Rules

Washington applies an estate tax to every decedent domiciled in the state at their death, as well as out-of-state decedents who own Washington State property. Tangible personal property and real property are generally treated as “owned” in the state where they are physically located. Intangible property, such as bank accounts, retirement accounts and ownership interests in business entities, is generally “owned” in the state of domicile of the decedent. The state applies an apportionment formula to any estate consisting of both in-state and out-of-state property. The apportionment formula means that all estates with a total value above the Washington estate tax exemption amount (currently $2,193,000) with any amount of Washington property will potentially be subject to estate tax (even if the value of the Washington owned property is less than the exemption amount).

While real estate is generally subject to estate tax in the state where it is physically located, if it is owned by a business entity, such as an LLC, it could instead be treated as intangible personal property and thus considered “located” for estate tax purposes in the owner’s state of domicile. For example, the estate tax location of real property in Washington owned by a California resident outright in their name would be considered located in Washington State for estate tax purposes, but if it was owned by an LLC, and thus considered intangible property, it would be located in the state of domicile instead.

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Rule change simplifies planning and eliminates uncertainty

In order to prevent out-of-state residents from shielding real estate located in Washington State from the estate tax through the use of business entities, the DOR has previously held the position that the business entity must have a true business purpose to qualify the real property as owned by the business entity and thus treated as intangible property. Starting June 1, 2020, the DOR has announced it will no longer use the “true business purpose” test and will treat all real property owned by an LLC as intangible personal property and thus subject to estate tax in the state of domicile of the decedent.

For Washington residents: this means any real property located out-of-state owned by a business entity that previously would not have passed the “true business test,” such as vacation or family legacy property, will now be included in their taxable Washington estate. If you own an interest in an LLC or partnership that owns real property located out-of-state, you should consult with your advisors about the implications of the new DOR ruling.

For non-residents of Washington who own real property in Washington: this ruling creates planning opportunities to potentially reduce or eliminate Washington estate tax liability on your estate by owning the Washington real property in a partnership or LLC. You should consult your advisors about the implications of the new DOR ruling.

Additional considerations

The new DOR ruling does provide simplicity and certainty about how Washington State will treat real property for purposes of estate tax apportionment. However, there are numerous other factors to consider in planning for real property. These include, but are not limited to, liability protections of LLCs, filing and administrative requirements of business entities, transferring of property that has a mortgage or other encumbrances, and estate and income tax implications in other states. Before transferring property into or out of a business entity, you should consult with an attorney to determine the various impacts and risks.

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This is a publication of The Private Bank at MUFG Union Bank, N.A. (the Bank). This publication is for general information only and is not intended to provide specific advice to any individual. Some information provided herein was obtained from third-party sources deemed to be reliable. The Bank makes no representations or warranties with respect to the timeliness, accuracy, or completeness of this publication and bears no liability for any loss arising from its use. Wealth planning strategies have legal, tax, accounting and other implications. Prior to implementing any wealth planning strategy, clients should consult their legal, tax, accounting and other advisers.