Understanding what happens when you inherit a house, as well as addressing the tough financial and emotional decisions on what to do with the home, can be intimidating.
What to consider when you inherit a house:
All three of these relate to each other. For most people, deciding what to do with the inherited property is based on the financial and legal responsibilities relating to the home, which in turn impacts how you’re taxed.
Let’s discuss the three considerations and the related responsibilities—both financial and legal.
If you inherit property, you may wonder if you’re responsible for paying taxes. Luckily, there’s no federal inheritance tax, although some states do have inheritance taxes. But for most people, inheriting property doesn’t trigger an immediate tax liability.
When a property is inherited, the IRS establishes a fair market value (FMV), which is the new basis for the property. This is called a step-up basis. This new valuation influences future taxes when the property sells.
Capital gains are a special type of tax relating to the profit generated by an asset, such as a house. The step up in basis means you’re only subject to capital gains taxes if you sell the home. You’ll pay taxes on the difference between the established fair market value at the time of inheritance and the selling price.
If your parents originally bought the home in the ’80s for $30,000, but its FMV is $400,000, your new tax basis is $400,000. If you sell the property for $400,000 shortly after inheriting it, you wouldn’t be subject to any capital gains taxes because there’s no profit. However, if you sell the property for $425,000, you’d pay capital gains tax on the $25,000 profit.
If you keep the home, you may be eligible for a capital gains exclusion. According to the IRS, you may qualify to exclude up to $250,000 of that gain from your income, or up to $500,000 of that gain if you file a joint return with your spouse, if you meet two conditions:
Inheriting a home can be a blessing or a burden, depending on several factors:
If the property has an open mortgage, it’s important to discern the type of mortgage and whether it’s due on sale or assumable. Most mortgages can be assumed by the mortgagor’s heirs, meaning the heirs take over payments and pay the remaining debt according to the original loan terms.
However, some loans, like reverse mortgages, specifically state that the unpaid balance is due on sale or when the mortgagor passes, requiring the heirs to sell the home to settle the debt.
The condition of an inherited property often impacts what the heirs decide to do with it. If the property hasn’t been maintained, it could need costly and time-consuming improvements. Coordinating a small- or large-scale renovation is a big task and should be carefully considered before deciding whether to keep the home or sell it.
Additionally, the heirs are now responsible for paying taxes, insuring the property, and maintaining it on an ongoing basis. For some, these responsibilities are too large of a burden — in this case, it may be easier to sell the home as-is. For others, it may make sense to fix up the home and keep it.
It’s fairly common for multiple siblings or family members to share ownership of an inherited house. For some families, this isn’t an issue. For others, having multiple heirs complicates things because each person has different needs and opinions. One sibling may prefer to sell the home for cash now, while another would prefer renting it for long-term income. One sibling may even want to move into the house.
The number of people sharing ownership and how they communicate and interact with each other often plays a large role in what’s done with the property.
One option when inheriting a home is making it your primary residence. If you want to move into a house with an outstanding mortgage, determine whether the debt obligation on the home makes financial sense. The mortgage balance may be more than the home is worth, the principal and interest payment (P&I) may be more than you can afford, or the ongoing maintenance (including property taxes and insurance) could be too high. Consider the cost of keeping the home before moving into it.
If there are no debt obligations and the home is owned free and clear, moving into it can let you sell your old primary residence and live in the new home debt-free. This is a great way to keep the home in your family, letting you make new memories where many good times were shared before.
If there are multiple heirs sharing ownership in the house, deciding who will move into the home can be challenging. For most, this option makes the most sense when only one person inherits the property.
When you move into an inherited home, you’re responsible for repaying any debt, maintaining the property, paying taxes and property insurance, and all other financial and legal responsibilities for the home.
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