Who would ever think that inheriting a piece of property would become a burden? Probably no one until it happens to them. Inheriting property can be life-changing in a good way and in a not-so-good way. Either way, there are several issues that can complicate your life if you’re not prepared for it. The good news is you have several options for what to do with an inherited property and can choose the one that best suits your needs and circumstances.
When you inherit a property, such as your parent’s home, you essentially have three options: Live in it, rent it out, or sell it. Regardless of which option you choose, it raises several issues that you need to consider carefully. There are financial and legal responsibilities, tax implications, and maintenance costs.
What are the Financial and Legal Responsibilities?
The biggest financial issue is if the house has a mortgage attached to it or the house was used as collateral for a loan. As the inheritor, you become responsible for the debt. You have to determine if the mortgage is assumable or due on sale. Most mortgages of inherited properties are assumable, which means you can take over the payments.
However, if there is a reverse mortgage on the home, the unpaid balance is typically due when the mortgagor dies, meaning you may need to sell the house to settle the debt.
One of the more common legal issues is when the property is co-inherited by multiple family members, which can get ugly if there’s no agreement on the disposition of the property. If you can’t agree on what to do with the property, you may need to sell it. Or, agreeable family members can choose to buy out the disagreeable family members.
What are the Tax Implications?
Generally, you won’t owe any inheritance taxes, though some states have their own requirements. Also, heirs receive inherited property on a stepped-up basis. That means, if your parents bought the home for $100,000 and its fair market value is $300,000 the day you receive it, you are not responsible for any taxes on the $200,000 gain. You will only be responsible for any gain in the home’s value beyond $300,000. However, you will be responsible for paying yearly property taxes on the house.
If you decide to live in the house, you could qualify for a capital gains exclusion when you sell the property if you live in it for at least two years and you haven’t used the exclusion on any other property. Single filers can exclude $250,000 of the property’s value, and joint filers can exclude $500,000. So, if you’re married and you sell the house for $500,000 gain over your cost basis, you would owe no capital gains taxes.
What are the Maintenance Issues?
It’s not uncommon to receive a property that is in disrepair or needs renovation. Whether you plan to live in it, rent it out, or sell it will require an investment of time and money. Even a property in good condition will require ongoing maintenance costs, especially if you rent it out.
What are the Options for an Inherited Property?
Understanding all the issues of inheriting a property can help you choose the option that makes the most sense for you. Essentially, you have three.
Live in the Property
Many people choose to live in the property they inherit for sentimental reasons. Maybe it’s their childhood home, or it offers a better living arrangement for their families. The primary consideration is the property’s condition and whether it will need repairs, improvement, renovation, or just a deep cleaning. It could take time to deal with the parent’s belongings and to improve the condition of the home. That needs to be factored into the cost. You’ll also have to consider whether you can cover the property taxes, which, depending on where it’s located, could be increased when the property changes hands.
If the inherited property has no outstanding debt attached to it, you could sell your existing home and live in the new home debt-free.
Rent it Out
If you’re happy with where you live, turning the home into an investment property could be a good option. In many parts of the country, rents are at a premium, so it could be a great source of income. As an investment, you can benefit from the passive rental income, which is taxed at a lower rate than your earned income. You’ll also enjoy the tax benefits of owning an investment property, which the IRS treats as a depreciable asset. Keep in mind that when you sell the property, the IRS will want the depreciated costs back, which can nullify the capital gains exclusion.
Your most significant consideration is whether you are prepared to become a landlord. Maintenance, repairs, and upkeep can be costly and time-consuming. You also have to deal with possible bad tenants and the gaps in rental income between tenants.
You can solve those problems by hiring a property management company that will take on most landlord duties, including collecting the rent. Depending on the location, property management companies charge between eight and 12 percent of the rent.
If you decide to sell the property, you won’t have to deal with the financial, legal, and other responsibilities of keeping it as your own or renting it out. However, you will need to spend time and money turning the house into a saleable condition. For some, that is no small job. It might need repainting, repairs, updating plumbing or electrical, among other things. That can be worthwhile if you expect it to increase the home’s market value. If a cost-benefit analysis shows that it wouldn’t substantially increase the home’s value or would eat into your profits, you could sell as-is.
It’s also important to keep in mind that if there’s a mortgage on the house, you will need to pay it off or continue the loan payments until it is sold. You can then use the sale proceeds to satisfy the debt.
If the property is underwater when you inherit it—the outstanding mortgage amount exceeds the home’s market value, you could discuss a short sale with the lender.
There is a Fourth Option
If, between the financial burden of financial responsibilities, tax implications, or improving the property seem too overwhelming—financially, emotionally, or practically—you could just decide to reject the inheritance. You could work with an attorney to legally not accept the property.
Inheriting a property is never a small matter. It invariably involves sorting out financial responsibilities, legal issues, tax implications, and many practical matters to determine whether you should keep the property, rent it out, or sell it. Understanding how each of these issues will impact you and your family is critical for choosing the best option for your needs and circumstances. It’s best to take your time and be methodical in analyzing the cost and benefits. You may want to seek the guidance of an attorney or accountant early in the process to ensure you clearly understand the issues and your options.
Important Disclosure Information
Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by Dechtman Wealth Management, LLC [“DWM”]), or any non-investment related content, made reference to directly or indirectly in this blog will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this blog serves as the receipt of, or as a substitute for, personalized investment advice from DWM. To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing. DWM is neither a law firm nor a certified public accounting firm and no portion of the blog content should be construed as legal or accounting advice. A copy of the DWM’s current written disclosure Brochure discussing our advisory services and fees is available for review upon request or at www.dechtmanwealth.com.
Please Note: DWM does not make any representations or warranties as to the accuracy, timeliness, suitability, completeness, or relevance of any information prepared by any unaffiliated third party, whether linked to DWM’s web site or blog or incorporated herein, and takes no responsibility for any such content. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly.
Please Remember: If you are a DWM client, please contact DWM, in writing, if there are any changes in your personal/financial situation or investment objectives for the purpose of reviewing/evaluating/revising our previous recommendations and/or services, or if you would like to impose, add, or to modify any reasonable restrictions to our investment advisory services. Unless, and until, you notify us, in writing, to the contrary, we shall continue to provide services as we do currently.
Please Also Remember to advise us if you have not been receiving account statements (at least quarterly) from the account custodian.
Join our newsletter
"*" indicates required fields