January 6, 2020

Are you a resident of another state who owns real estate in Illinois? Are you an Illinois resident who owns real estate in another state? Do you advise such a person? If so, you should take this pop quiz about the Illinois estate tax.

Bob has assets of $10 million, consisting of a $1 million home in Chicago, a $1 million home in Miami and an $8 million brokerage account. Bob was a long-time Illinois resident, but recently retired and changed his official residency to Florida. Bob spends six months and a day out of each year in Florida, is registered to vote in Florida, and does not take the Illinois homestead exemption on his home in Chicago. Bob has never been married.

Bob dies in 2019. Will Bob's estate owe any estate tax?

In answering this question, your thought process might be:

  1. In 2019, the federal government imposes an estate tax on estates over $11.4 million.
  2. Florida imposes no state estate tax.
  3. Illinois imposes a state estate tax on estates over $4 million.
  4. Bob is not an Illinois resident, so his Illinois situs assets consist only of his Chicago house (valued at $1 million).
  5. Therefore, Bob's estate will owe no estate tax.

But you would be wrong. Bob's estate will owe $92,692.30 of Illinois estate tax.

Surprised? You're not alone. What's the deal?

The Illinois estate tax statute (35 ILCS § 405) is not easy to read, even for tax attorneys. Section 3(c) says:

"[T]he amount of the Illinois estate tax shall be the state tax credit, as defined in Section 2 of this Act, reduced by the amount determined by multiplying the state tax credit with respect to the taxable transfer by the percentage which the gross value of the transferred property not having a tax situs in Illinois bears to the gross value of the total transferred property."

In English, this means the Illinois estate tax due equals the amount of tax that would be due if all of the decedent's assets had Illinois situs multiplied by the percentage of the decedent's assets that actually do have Illinois situs.

Applying this to Bob's estate:

The amount of tax that would be due if all of Bob's assets had Illinois situs is $926,923.

10 percent of Bob's assets have Illinois situs.

$926,923 multiplied by 10 percent equals $92,692.30.

At this point, if you are a normal person, you might think: Wow, that is unfortunate for Bob!

But if you were a tax lawyer, you might think: What happens if Bob transfers his house to a single-member LLC? Would doing so effectively convert Bob's interest in the house from real property to personal property, thereby making its tax situs Bob's state of residence (Florida) rather than Illinois?

The answer is "probably." No published Illinois case addresses the issue exactly, but helpful precedent exists. Any non-residents of Illinois who own Illinois real estate should therefore explore this strategy.

Taxpayers in the opposite situation – Illinois residents who own out-of-state real estate – should consider taking the opposite approach. Out-of-state real estate owned directly by an Illinois resident is not subject to Illinois estate tax. However, transferring out-of-state real estate to an LLC could very well cause the real estate to become subject to Illinois estate tax. Therefore, holding the real estate directly – not through an LLC – is the best approach for estate tax purposes.

There are, of course, many non-estate-tax reasons to own real estate in one manner or another. However, Illinois residents with out-of-state real estate, as well as residents of other states with Illinois real estate, should be aware of the estate tax ramifications.

This article contains material of general interest and should not be construed as legal advice or a legal opinion on any specific facts or circumstances. Under applicable rules of professional conduct, this content may be regarded as attorney advertising.