The thought of inheriting a home might at first put images of dollar signs in your head. But if you have inherited property from a loved one, it’s not as simple as passing over a set of keys. There are all sorts of legal and tax hoops to jump through if you want to make the most of your new asset.
If you are in a situation where you stand to inherit property or have already done so, you’ll need all the facts to make the best decisions concerning your new asset. This guide will explore some topics you’ll want to explore further to make the most of your inherited home .
Get a lawyer
As soon as you are aware of a potential inheritance, seek legal help from an experienced estate planning lawyer who’s also familiar with real estate law. A lawyer will navigate court proceedings and help you make strategic, informed decisions that can have an impact on the final value of your inheritance. Since laws governing inheritance and probate vary from state to state, it’s crucial to find an expert with knowledge about the laws in your state for specific recommendations.
Check for any liabilities
It’s entirely possible to inherit property with encumbrances or interests attached to it. The existence of additional heirs, even estranged ones, could mean that the property actually belongs to a number of people. These interests must be figured out and settled in order for one or more people to take ownership of the property as an inherited asset.
Also, there could be liabilities like back taxes, unpaid utility bills or child support expenses that result in liens against the property. There could even be additional mortgages or reverse mortgages against the home. If you inherit a home with a mortgage(s), that debt must be paid off before you can take legal possession.
If there are multiple heirs involved, along with tons of outstanding debt against a property, you may decide not to pursue claiming it based on the value of the home. The trouble of probating the will and acquiring the property could outweigh what you stand to gain based on appraised value.
Get an appraisal and estimate your tax liability
Taxes go hand in hand with inheritances, especially when inheritances involve property. The amount of these taxes will depend on the value of the real estate. That’s another reason why getting an appraisal of the inherited property is recommended.
An appraisal of the inherited home can be useful for determining inheritance, estate or capital gains taxes. Each state is different and may impose only an inheritance tax or an estate tax or both.
If you sell the home, you’ll only need to report your inheritance on your tax return for the year you sell the home. You’ll report this activity on Schedule D of your tax return. The date-of-death valuation (i.e. stepped-up basis) is what is used to determine the value of the estate to be taxed.
There is an exception to taxes on a sale: if you move into and live in the home. In this case, it’s considered your personal residence and not an investment property. For the most part, personal residences that are sold do not need to be reported on a tax return if the owner has lived there for two years or more.
If you decide to keep the home and rent it out, you’ll have to report your rental income and expenses on Schedule E of your Form 1040 for tax filings. Once you sell it, you’ll use your stepped-up basis to pay taxes on the profit of the sale as mentioned above.
A home appraisal gives property a value in dollars based on the home’s characteristics and nearby homes with comparable features. You’ll want to determine the value of the home as soon as you can. Why? As mentioned, the value of your inheritance could be affected by a number of variables: taxes, the presence of multiple heirs, even outstanding debts against the property.
You’ll want to get an appraisal as close to your relative’s date of death as you can, to determine the tax situation. Your “initial investment” amount is set at this date and will be the basis for calculating taxes due (should you profit from the sale of the home).
For example, if Grandpa Joe purchased a home for $60,000 in 1965 and died in 1995, you’ll want to know the value of the property in 1995 to understand how much the home has grown in value. If the home appreciated to $135,000 by 1995 and you sell it for $140,000 any time after this, you’ll owe taxes on that $5,000 profit. This amount would be much less than taxes based on profits made from the 1965 purchase amount.
If you decide you don’t want to pay the capital gains taxes on the inherited home, you’d have to live in the property for at least two years. Once you sell the property, $250,000 of the profit will not be taxed ($500,000 for married couples.) There are many other ways to further shelter profits that exceed this amount, but this is a good starting point.
Estates with property worth several million dollars or more will have to pay an estate tax. This tax is on your right to transfer property at death. Currently, estates worth almost $5.5 million will owe up to 40 percent in estate taxes.
An appraisal will help you make strategic moves with your inherited property. So, the sooner you obtain one, the sooner you can make make decisions to move forward (or not) with the property.
Set yourself up for a smooth transfer
There are many ways that real estate can be transferred from the deceased (decedent) to an heir. With a few exceptions, as soon as someone dies, any assets titled in the decedent’s name transfer to his or her estate.
Once the court determines that you are a rightful heir to the estate, you’ll obtain a court order that grants you rights to possess the property. From here, you’ll want to make sure the title and deed to the property are in order for a proper transfer.
An experienced real estate lawyer should be able to handle all the research related to the property to make sure you don’t run into problems with either the initial transfer or a sale down the road. John W. Graziano, an attorney based in Lee, Mass.,suggests heirs obtain a title search and insurance to ensure their rights to occupy, rent or sell the property they’ve inherited.
The state you live in (or own property in) creates this estate entity. In the probate process, the state will attempt to distribute estate assets to all heirs on record.
Real estate, unless previously directed by the decedent, will also pass into an estate for distribution. The complexity of the probate process and timeline depend greatly on the type of estate your relative had and whether there was a will, a living trust or some other circumstance. All such variables factor into the manner in which you receive your real estate inheritance.
For each situation, you’ll need to know your options and what to expect from the transfer process.
Case #1: My relative had a will
In this case, your relative has expressed the desire to give you the property. In somes states, a will can help expedite the probate process because the wishes of the decedent are plainly stated. You’ll need to file a copy of the will with the local county court to begin the probate process so that assets, including real estate, can be distributed.
Case #2: My relative did not have a will
If there was no will, the decedent's assets will enter into a “intestate” probate proceeding. In this case, you can still start the probate process at your local county courthouse. A judge will decide how to divvy up assets since your loved one did not leave any instructions for disposition of assets.
For those who die without a will, the courts will distribute assets according to the state inheritance laws. These laws, known as intestate inheritance laws, will dictate who gets what in probate proceedings. The most likely heirs of an estate’s property are spouses, children and siblings, but the court will have the final say.
Even if your relative did not have a will, an experienced probate attorney knows how to handle the process of opening the estate. The lawyer will present evidence to the court, informing it of the existence and whereabouts of living heirs for estate asset distribution.
Case #3: My relative had a living trust
Sometimes a person may transfer ownership of property to an entity called a living trust. A trust is a legal document that tells a trustee, chosen by the creator of the trust, how assets should be handled in the event of death or incapacitation.
Unlike with probate, which is handled by public courts, the distribution of assets in a trust can be handled privately, quickly and with less expense. Assets in a trust do not have to go through probate. That’s why many people choose trusts instead of, or alongside, a will.
If your relative had a trust that owned the real estate you are due to inherit, then the trustee will transfer ownership of this asset to you via deed, title or both.
Case #4: I am a joint owner of the property
If you are a joint owner or joint tenant of a real estate asset, there is no need for probate, in most cases. With joint tenancy, the ownership of the deceased’s property passes to survivors in the joint tenancy.
Though joint tenancy can be in place for many reasons, this is most common when a married couple own property together. When a spouse passes away, the transfer can be as simple as providing a death certificate to the title company. The company can easily update the title with this information. If this applies to your situation, you’ll still want to consult your CPA and/or attorney for next steps regarding this arrangement.
Case #5: My relative had a small estate
In some states, there is a “small estate” process that allows you to skip probate altogether. In many cases, you can claim real estate and other minor assets via affidavits or briefer court proceedings.
Each state, however, has its own threshold for the dollar amount that would classify an estate as “small.” In some states, there are also expedited proceedings for estates that only contain real estate. If you can receive your property inheritance without the longer, more extensive process of probate, a small estate proceeding is ideal.
Make a plan to sell, refinance or keep the home
There are different options available to people who inherit a home. Depending on your goals you can choose to sell it, rent it out or live in it.
Selling the home you've inherited
In this case, you’ll want to make sure that you care for the home until the sale is complete. Make sure all expenses are paid, like the mortgage, property taxes and utilities. Keep the properly well maintained and in livable condition so that there are no problems when it comes to selling the house. When the sale is complete and the balance of the mortgage or any other debt in the estate paid off, the sale proceeds can be divided among heirs.
A home with a mortgage usually has a due-on-sale clause to require full payment when the borrower dies. However, this clause is suspended in two cases:
- Because of the death of a joint tenant
- Property is transferred to a relative resulting from the death of a borrower.
This means that the heir can keep making payments on the property under the existing terms of the mortgage. However, if there are other plans to sell the property or transfer interest from one or more heirs to another, you will have to pay off the existing mortgage.
Keeping the home to rent it out
If you are looking to become a landlord and rent the home, you can take ownership of the property. There may be additional steps to take if a mortgage still exists on the property or if there are are additional heirs involved. You should know, too, that there are tax implications to receiving rental income (discussed below), but it could still be a viable way to get more cash from your inherited property
Keeping the home and live in it
Finally, you could keep the home and use it as your primary residence. Again, with a mortgage and multiple heirs involved, there will be more steps to that you can have official ownership.
Refinancing the mortgage
If one or more of the heirs decide to keep the inherited property as an rental income property or a primary residence, the mortgage on the home may have to be paid off before taking ownership (except in the cases mentioned above).
Though a mortgage cannot be issued to an estate, lenders will typically work with the estate’s attorney for a solution that satisfies the mortgage debt. This may include selling the home or allowing an heir to refinance the balance of the mortgage due on the home.
If there’s more than one heir to the estate and one decides to take sole ownership of the home, this heir could arrange a refinance and purchase transaction. In this type of transaction, the proceeds of the refinance can be used to purchase the other heirs’ interest in the home.
Inheriting a home can be silver lining when grappling with the death of a loved one. However, if you don’t take all the steps required to obtain rightful ownership, the property could be another source of hassle and a monumental time-suck.
Graziano urges heirs to work with a lawyer on all aspects so they understand the inheritance process. In this way, they can get the most value from their inherited assets, with the the least amount of hassle and the fewest surprises.
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