Original Article: https://www.zillow.com/sellers-guide/what-happens-when-inheriting-property/
Inheriting a house — while a generous gift from a loved one — kicks off a process that can be fraught with emotion. You’re likely receiving this property as a result of a loved one’s death, and the financial decisions that come with inheriting property can be stressful and confusing.
The best way to move forward is knowing your options, assessing the financial consequences of your choice, and seeking expert assistance in navigating the tax and legal requirements.
Tax implications: Do I have to pay tax on an inherited property?
Once you learn that you’ve inherited a house, you’re likely wondering: Do I have to pay an inheritance tax on property? The act of inheriting a property doesn’t trigger any automatic tax liability, but what you decide to do with the house — move in, rent it or sell it — will cause you to incur property taxes, capital gains taxes or other expenses (more on that below).
What are capital gains taxes?
Capital gains taxes are taxes you pay to the federal government based on profits you earn from the sale of an investment. For example, capital gains taxes are paid on the difference between what you originally purchased a property for and what you sell it for (typically you won’t pay capital gains taxes on the sale of your primary residence, as long as you’ve lived in it for two of the last five years).
If you do have to pay capital gains taxes, your rate is based on your taxable income. In most cases, when you inherit a home, you’ll be protected from the majority of capital gains taxes because of what is called the step-up tax basis.
What are step-up taxes or the step-up tax basis?
As the recipient of an inherited property, you’ll benefit from a step-up tax basis, meaning you’ll inherit the home at the fair market value on the date of inheritance, and you’ll only be taxed on any gains between the time you inherit the home and when you sell it.
For example, let’s say the house you just inherited from your grandmother was originally purchased in 1960 for $25,000. If the house is now valued at $425,000, does that mean that when you sell the home, you’ll be taxed on a $400,000 profit? Luckily, no. You’ll only be taxed on gains during the short time period between inheritance and sale.
I just inherited a property. What’s next?
What you decide to do with your inherited property has to do with the financial status and physical condition of the property, along with any time constraints.
Is there a mortgage on the property?
If there is a mortgage on the home you’ve inherited, the details of the mortgage might affect how quickly you decide to sell or rent the property.
- Due-on-sale clause: See if the mortgage has a due-on-sale clause, which states that the entire loan is due and payable if the borrower transfers the property to someone else, especially a non-family member. This clause may make it necessary for you to either pay off the mortgage in full or sell the property. When family members inherit a property, they can usually just assume the mortgage payments instead.
- Reverse mortgage: In a reverse mortgage, which is a financial product popular with older homeowners looking to access their home’s equity without moving, the original owner receives ongoing cash for the equity in the home, repaying the loan upon moving out. Upon the original owner’s death, the beneficiary often has a limited time to repay the amount due — usually six months. You’ll need to pay the balance with your own funds, sell the home to satisfy the loan or get a new loan in your name to cover the amount due.
- Underwater properties: If the property you’re inheriting is underwater (meaning more is owed on it than it’s worth), the issuing bank may agree to let you do a short sale on the home, accepting less for the property than the remaining loan amount.
- Mortgage paid off by the estate: While the person leaving the home to you may have had a mortgage on the property while they were living, it’s possible that the mortgage was paid off by their estate, and you own the home free and clear.
Does the property need repairs?
- Repairs to sell: Just like any home you’d purchase for yourself, it’s always a smart idea to get a home inspection upon inheriting a home. You’ll want to know about any big-ticket repairs that need to be done before selling the home — think furnace, foundation, roof and windows. Home inspections cost between $250-$700, depending on the size of the home.
- Repairs to rent: Renters care less about the long-term condition of a property and more about the creature comforts, like new carpet and fresh paint.
- An alternative: Buyers will want big repairs completed before purchase. If you’re interested in selling the home without doing major repairs, consider selling it to CB Home Solutions by clicking here
Are there multiple stakeholders in the inherited property?
It’s very common to inherit a property with another stakeholder, like a sibling or other family members. Of course, multiple stakeholders make things more complicated.
Consider these options:
- Buyout: If one sibling wants to keep the home and the other wants to sell, one can buy the other out, either in cash or by financing half of the home’s value. Out-of-pocket expenses include closing costs and an appraisal.
- Promissory note: If you want to keep the property, your sibling wants to sell and you don’t have access to a mortgage, you can record a promissory note that outlines how you’ll pay your half of the home’s value back to your sibling — in monthly installments plus interest. You’ll effectively be buying out your sibling over time, and they’ll receive some interest income along the way.
- Sell and split the profits: Perhaps the most straightforward option, you and your sibling agree to sell the home, pocketing your half of the proceeds after expenses and commissions.
- Rent and split the profits: If the real estate market isn’t strong, you may decide it makes more financial sense to rent the property. You and your sibling would pocket whatever profit is left over from the monthly rent, after maintenance and property management costs.
- Suit for partition: If stakeholders can’t agree on what to do with a property, you’ll have to get the courts involved by filing a lawsuit for partition, which essentially asks a judge to order the sale of the home. This can be a timely and expensive process, with legal fees lowering the profits you’ll receive far below what you would have pocketed by selling in the first place.
3 options for inheritance of property: Move in, rent or sell
After gathering the necessary financial information, assessing the physical state of the home and communicating with other stakeholders, it’s time to decide on what to do with the home you’ve inherited. Your decision to move in, rent or sell the property will depend on many financial, circumstantial and market decisions.
Move in
- Financial impact: Whether you have a mortgage payment or not, you’ll be on the hook for maintenance, HOA fees and the other unexpected expenses that come with homeownership.
- Tax liability: Just the act of inheriting a home doesn’t make you responsible for additional taxes in most states, except for the yearly property taxes you’ll pay as the new owner.
Turn it into a rental
- Financial impact: First, you’ll need to get the home rental-ready. Then factor in costs like 24/7 maintenance support, property management and tenant gaps.
- Tax liability: Just like any home you own, you’ll be required to pay property taxes. You may, however, be able to deduct the expenses related to upkeep and maintenance on your taxes.
Sell it
- Financial impact: You’ll have to cover any costs related to listing your home, including any repairs that need to be done beforehand, real estate agent services, staging and closing costs.
- Tax liability: If you fall within certain tax brackets, you’ll be required to pay capital gains taxes on the difference between the fair market value of the home when you inherited it and the sale price.