Hey everyone, it’s Finance Fridays again. Today I’m going to ponder what to do if someone was “Inheriting a House“.

Inheriting a House

First things first: I’m not inheriting a house.

The reason I’m writing this blog post is because a friend of mine inherited a house along with siblings. He talked to me a little about it. Since I wanted to learn more, I started doing some research into it.

There is a ton of information you can find online which I’ve read through. Here’s what I found, and my thoughts.

Well, before we move on, if you inherit a house that is “underwater” meaning the house will sell for less than the debt it has, then there may not be anything you need to do. You may need to do a short sale on the house to close out the debt. Hopefully there is enough money in the rest of the estate to cover any remaining debt. In the event that the expenses of inheriting the house are less than its value, you may to work with an attorney to not accept the inheritance.

Now then, let’s look at a scenario where the house has equity.

Move in, Rent, or Sell?

The reality of the situation is you will need to decide what to do with the house. Of which, you need to think about moving in, renting, or selling.

In certain situations, it may make sense to just move in. Perhaps this house or bigger (or smaller) for your current living situation and would benefit you to either stop renting, sell your other house, or rent out your other house.

For some it may not be possible to move in to the house, like if it was in another state for example. However, if you want to keep this house “in the family”, you may need to try to rent it out.

If no one in the family needs it, then the best option may just be to sell it.

Moving in

Let’s say you’ve decided to move in.

Just make sure you’re aware that the property taxes on the property will likely increase significantly, especially if the house was bought a long time ago. The reason for this is because of the “stepped-up” value that occurs upon death.

Of course, the house may need a little Tender Loving Care and/or renovations, especially if it hasn’t been lived in for awhile. Get a home inspection and look at how much work the house needs right now and in the foreseeable future.

Of particular note is that if you do decide to move into an inherited house, make it your principal residence (at least 2 of the last 5 years before sale), and sell it later, you can potentially qualify for a capital gains exclusion. This is up to $250,000 for single filers, $500,000 if you’re married and filing jointly without owing capital gains taxes. 

Renting

Renting may be a viable option if you believe the house is in a good rental market. However, it may be difficult to keep tabs on it if you aren’t within driving distance. Most likely you’d be relying on a property manager to take care of things for you, which can cost between 10-30% of the rent.

Don’t forget to change insurance policies to a landlord insurance policy too.

There are other things to consider like the depreciation expense to increase your taxable rental income. The house (not the land) is a depreciable asset and a certain percentage of its value can be deducted annually. You can also depreciate improvements that add value or extend the life of the property.

However, you will need to pay this back when you sell the house which would increase your capital gains taxes. Additionally, since it’s not your principal residence, you don’t qualify for capital gains exclusions.

Selling

Let’s say you’ve decided to sell.

As it stands currently, the way an inherited house is taxed is for the beneficiaries is at a “stepped-up” cost basis. What this means is that the beneficiaries will not pay capital gains taxes on any appreciation which occurred up until the deceased’s time of the death.

You inherit the home at the “fair market value” of the home at the time of death. The beneficiaries will only pay taxes on any appreciation between the time of death (fair market value) and (actual sale price).

For example, let’s say you inherit a house and its fair market value at the time of death is deemed to be $500,000. If you were to sell it for $500,000, then the taxes you would pay on that sale would be zero dollars — regardless of when you sell it. However, let’s say later on, it has appreciated to $600,000 and it was sold for $600,000, you would be taxed on the amount of above the originally derived fair market value.

In this example, you pay taxes on that $100,000. Of course, if you make it your principal residence for at least 2 of the past 5 years before sale, you could qualify for capital gains exclusion and not pay any capital gains taxes ($250,000 for single filers, $500,000 if you’re married and filing jointly above).

I’ve talked about it before, but you may also need to be aware of any estate taxes that may come with your inheritance.

The elephant in the room

The above options are pretty cut and dry when you’re the solo heir apparent. Things become a little more difficult when you have siblings or multiple other heirs involved.

For example, let’s say you inherit a house with your sibling and are now joint-owners. Neither of you plan to live in the house. However, one of you wants to sell it and the other wants to keep it and rent it. If you both don’t agree on something, then nothing gets done. If neither will budge, the only option would be for one to try to buy out the other. Either by using a mortgage, promissory note, or giving up some other part of the estate in return.

The worst possible scenario would be having to get lawyers involved. This will cause costs to skyrocket and dramatically deplete any potential inheritance very quickly — please don’t do this.

How do you prevent this from happening?

It’s a pretty simple answer, but I think open lines of communication between the heirs is key. On top of that, these are big decisions and perhaps it’s reasonable to put them off for few months if financially feasible. I think these kind of decisions are best made with a level-head and not when emotions are high or during stages of grief.

Additionally, the potential heirs should be kept aware of what the deceased’s plan is/was for their property. I don’t want to get into it too much, however, I found these articles to help people plan. I will likely refer back to these 30 years from now, when I actually have some assets for my children to inherit.

How to Avoid Family Feuds Over Your Inheritance

9 Ways to Make Things Easier for Your Survivors

What would you do?

Well, I can’t speak for my siblings.

However, I think we’re all pretty level-headed individuals and I don’t foresee any of us being in any kind of dire straits. In that sense, I don’t think any of us would need the house nor need any money. That said, in the event that one of us was in financial trouble, I think the best option would be to sell and split things evenly.

However, my parent’s house is their “forever home”. It was built for us, and no one has lived in except for us. They will never sell it. For that reason, I would think my parents would want us to try keep it in the family if at all possible. I think that my siblings and I would try to find some way to make that happen. Whether that means one of us moves in or we try to rent it out, I think keeping the house in our family is something that my parents would want. Perhaps someday one of my children, a nephew, a niece, or later generations will need that house.

TL;DR

Inheriting a house boils down to: move in, rent, or sell.

I talk about each of these and the potential tax implications.

I also briefly mentioning how things can get difficult when multiple heirs are involved — which becomes even worse when lawyers are involved.

What do you guys think? What would you do?

-Sensei

Agree? Disagree? Questions, Comments and Suggestions are welcome.

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