Congratulations! You’ve inherited a property. Now what? Inheriting a property can often be overwhelming for many people, especially if you are not currently a homeowner or have little experience owning and maintaining a home. You probably inherited this property as the result of a death in the family or a family property transfer. Whether you are excited about receiving this property or not, you will have a number of decisions to make regarding what to do with it.
There are a few things you should initially consider when you inherit the home:
- What are the financial obligations of owning this home and can you afford them?
- How will this ownership affect your taxes?
- What is the best course of action for you/your family? Will you sell it, rent it, or move into it?
Some of these options may be more complicated if you inherited with another family member, i.e. you are sharing the new ownership. We’ll go over the steps for that later in this article. Additionally, we’ll cover financial obligations, tax implications, and a review of what you can do with the property: rent, sell, or keep it.
Financial Obligations of the Property
The first thing you’ll need to consider when taking over the property is whether or not it has an open mortgage (whether or not the home is paid off). In most cases, the inheritor can assume said mortgage and continue to make payments. However, there are some situations where the type of loan states that if the mortgage holder dies, the balance is due up front. This typically results in the immediate sale of the home.
Another big factor is the condition of the home. Has the home been maintained over the years, or are there clear repairs and renovations that need to be made? Home repairs can add up quickly but will likely be necessary if you choose to rent or sell the property. Not only is there a cost here, but it will take up a chunk of your time as well. If the home has not been well maintained and you are unclear as to the extent of any potential damage, it might even be worth it to get a professional home inspection. This will give you a better understanding of the health of your home and help you get out in front of any issues if you decide to sell it or rent it.
The home will need continued maintenance should you choose to keep it in the family or rent it to tenants. This is something that you will want to keep in mind when deciding what to do with the home.
Capital Gains Taxes
Capital gains taxes are taxes on the growth in value of investments incurred when those investments are sold. In terms of real estate, the capital gains tax is only applicable if the home is sold. When the property is inherited, it needs to be reassessed for fair market value (FMV). Taxes will be paid based on the difference between the established fair market value at the time of inheritance and the sale price of the home.
For example, if your family bought the home for $40,000 in 1975 but the new fair market value is $500,000, the new tax basis will be $500,000. If you sell the home for $500,000, you won’t be subject to capital gains taxes. If you sell the home for $575,000 you would pay taxes on the $75,000 profit made from the sale.
There is also a capital gains exclusion. This applies if you sell the home, but have also lived in it for a specified period of time. The capital gains exclusion rule states that if you live in the home for at least two of the five years prior to selling the home, you may qualify to exclude up to $250,000 of the gains from that income, or $500,000 if you file taxes as married. This rule only kicks in if you have not already claimed a capital gains exclusion within the last two years on another residence.
California’s Proposition 19: Effective 2021
In early 2021, Proposition 19 went into effect in California. This proposition states that children who inherit their parent’s or grandparent’s home will no longer receive a tax break should they choose to use it as a second home or rent it out. As of February 16, 2021, the option to transfer up to $1 million of assessed property that is not the primary residence was completely eliminated.
There are only two ways that a property can be transferred without reassessment: the beneficiary intends to use the primary residence being transferred as his/her primary residence, or the fair market value of the primary residence at the time of transfer does not exceed the transferor’s assessed value by more than $1 million. Additionally, this new law does not apply to properties held in LLCs or other legal entities.
It is highly recommended to consult with your attorney regarding your properties if you had planned to make this kind of transfer.
If the Home is Left to Multiple Heirs
If you inherit the property with siblings or relatives, things can get more complicated. You will have to decide as a group what the best option is. If an option isn’t unanimously agreed upon, you can do one of the following things.
Buy the Other People Out
If only one person wants to keep the home, they can offer to buy the others out.
If you want to keep the property, your relative wants to sell and you don’t have access to the mortgage, you can create a promissory note. A promissory note is a legal document that outlines in writing the intent to pay a sum of money to one party from another, either at a fixed or determinable future time or on demand of the payee.
Rent or Sell and Split Profits
If you want the home to remain in the family, suggest renting it out and splitting the profits. This allows you to have passive income and eventually sell or move back in, should either family member desire. If neither cares about keeping the property, you can sell it and split the profits and expenses required to sell.
Lawsuit for Partition
If no agreement is reached between all parties, then your only option is to go to court and file a lawsuit for partition. This will essentially force the sale of the home, However, these lawsuits can be expensive and take away from any profit related to the sale of the home. It’s best to avoid this option if at all possible.
The first option is to move into the home yourself. This can be great if you have never owned a home before or would prefer to sell your previous home and move into this one. However, as mentioned above, you need to decide if this is a decision that makes sense for you financially. While it might be great to keep the home in the family for yourself or future generations, if the mortgage is outside of what you can afford, you might be better off selling.
If the mortgage is paid off, it might be better to sell your current residence (if applicable) and move into the inherited property. This is a better way to keep the home in the family while remaining financially stable. This can get more complicated if the home is left to multiple heirs. In those cases, you may have to decide who will move into the house, if anyone, or what the best financial decision for all parties is.
Rent It Out
If you are not planning to move into the home or have a family member move in, renting the home out is a fantastic option. This option allows you to maintain ownership when you don’t need or want the property for your own residence. Renting it can help you pay off your mortgage on your own residence, too.
Depending on the area the home is in, it will either be in a cash flow market or appreciation market. Cash flow markets are great because you will see more monthly income from your rental property. Appreciation markets accumulate their value over time, so whenever you want to sell, you’ll be able to get more bang for your buck.
Renting the property can be a daunting idea if you have never been a landlord or owned an investment property before. Thankfully, there are plenty of materials and guides out there that are designed to help you rent out the home, keep great tenants, and adhere to laws that affect rental properties. Before you commit, look into what the responsibilities of a landlord are. Being a landlord can be a time-consuming task, often referred to as a second job.
If being a landlord doesn’t fit your schedule or doesn’t interest you, you can look into hiring a property manager. This is a great alternative if you don’t want to manage it yourself but you want to hold on to the property. A property manager will typically charge a flat percentage as a management fee with possible additional fees.
One downside of renting the home is that you won’t be eligible for a capital gains exclusion. On a positive note, there are many other tax advantages that come with renting out your property, one being that rental income is taxed lower than your ordinary income.
If you’re not interested in keeping the property, you can sell it. This is a good option if you and your family members have no interest in keeping the home in the family and are looking to get cash sooner rather than later.
There are still costs associated with selling the home. You’ll have an agent commission, closing costs, and any associated debts that need to be paid. On top of that, you may decide to fix up the home a bit before putting it on the market. Depending on the extensiveness of these repairs, it could end up costing you more than expected. You may even decide to upgrade parts of the home to increase the odds of selling faster. It’s important to see what kind of homes are in your immediate neighborhood and what the average selling prices are. Upgrading the home too much for the area can actually make it harder to sell.
Different neighborhoods will have a better market than others. Make sure you do your research on market conditions and when is the best time to sell in your area. As a whole, San Diego currently is in a sellers' market, meaning you will likely be able to sell in a decent amount of time if your property is priced well.
These are the basics of what happens and what decisions need to be made when you inherit a property. If keeping the property in the family is important to you, you may prefer to move into it yourself or rent it out temporarily. Should you prefer some quick cash, selling could be the best choice.
It’s always recommended to consult with an attorney and financial advisor prior to making any firm decisions regarding an inherited property.
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