The passing of a family member or other loved one can bring numerous stresses. It's never easy to lose someone you love, and the stress and grief that comes with the death of a parent, family member, or close friend can make an inherited property seem like more of a burden than a blessing. Not too mention that with the gift of an inherited home or real estate comes several issues to work through relating to paperwork, legal issues, and taxes.
But navigating through difficult decisions can be somewhat easier if you are informed about the financial benefits and challenges, including taxes, that accompany your inheritance of a family home.
So You Just Inherited a Home. Now What?
When you first learn that you've inherited property, you may feel a range of emotions. One of the first things you'll have to decide is what you'll do with the home. There are generally three options.
Move into the house.
There are a few reasons you may choose to claim an inherited house as your own. Maybe you're not yet a homeowner, and this is the right opportunity for you to change that. It's also possible that your newly inherited home is larger or in a better location than your current house. Or, maybe it's a better deal than making your current mortgage payment or writing a monthly rental check. Either way, claiming homeownership of an inherited home is a great option.
Though, if you do decide that moving in is the right option for you, it will not be a tax-free process. You'll have to assume the property taxes on the house. Be aware that it's possible for these to increase because many states reassess property values when a house changes ownership. However, if you stay for at least two years, you could avoid having to pay capital gains taxes on your inheritance under the home sale tax exclusion.
Rent it out.
Depending on whether you will owe any money on the mortgage or if there are any required updates or repairs to make, renting the home can give you some added income.
The good news from a tax return perspective is that any money you spend on the property (such as maintenance, repairs, and even the interest on any mortgage) can all be deducted from your taxes. If you're actively involved in renting the house and serving as the landlord (in other words, you don't hire a management company to do the work for you), you may be able to deduct the costs associated with that.
Sell the house.
You can put the property up for sale, which may be the easiest choice if you share the inheritance with another person or if there are expenses like repairs, HOA fees, and property taxes that you don't want to assume yourself.
When you inherit property, you're allowed to use what's called stepped-up basis rules. In short, you will only pay taxes on the amount the property appreciates between the time you inherit it and the time you sell it. So if your parents paid $50,000 for the house decades ago, and today it's worth $350,000, you don't have to pay capital gains taxes on that $300,000. Instead, you just pay taxes on the difference between $350,000 and the price you sell the house for. Unless you do some major upgrades, this is usually reasonable.
Consulting a tax attorney or real estate attorney can help you calculate your tax burden for each option. To make the right decision, you'll need to have a clear picture of the property's value, whether there is any remaining mortgage or liens that you'll have to consider, and what your tax burden will be if it is sold right away.
The Best Way to Sell an Inherited House
If you've chosen to sell the home you've inherited, there are several challenges to navigate as you proceed with the sale.
First, you'll be responsible for preparing the property for sale. With many inherited homes, there are personal belongings that must be sorted through and moved, sold, or donated. This can take some time to complete, depending on if other family members are willing and able to help or if you hire a company to liquidate the home's contents through an estate sale. In many cases, you can locate professionals like Weeks Auction Group who can assist with selling not only the property but the contents of the estate.
You'll also need to wait until the deceased's estate has gone through probate, or the legal settling of the will. The exact process for this depends on your state, but in many cases where real estate is involved, the total assets may exceed the minimum for going through a simple or summary probate. This means that you could be waiting months — or even years — for the probate process to wrap up.
Once the house is legally yours to sell, you'll need to set an asking price. Take into account any existing debts or mortgages that will need to be paid, as well as the average selling price for similar properties in your market. Researching and setting a price, followed by waiting for and negotiating any offers, can take several weeks.
If you're feeling overwhelmed, and not sure about valuation or the selling process, a knowledgeable auction group like Weeks Auction Group may be a good option for selling your inherited house. With more than 60 years of experience selling properties, the experts at Weeks can help you handle some of the more stressful aspects of planning a sale, listing the property, and managing the transfer to a new owner.
What Taxes Do I Owe on an Inherited Home?
No tax collector will be beating down your door the moment you inherit a home, nor will the IRS send you nasty letters with tax bills due upon receipt. You do have time to consider your options and make the right choice for the real estate you've just inherited. What you decide to do with the property will determine the taxes you'll have to pay.
What Is Inheritance Tax?
If you live in one of six states — Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania —you may need to pay inheritance taxes. As the name implies, these are taxes assessed on the property you inherit. However, even in these six states, the tax is only due if the estate had assets over a certain amount (usually more than $1 million). For many people who inherit family homes, this doesn't come into play. If it does apply to you, you will likely have to pay regardless of whether you keep, rent, or sell the house.
Some people get estate taxes and inheritance taxes confused. Estate taxes are charged on the total assets and come out of the estate before those assets are divided among beneficiaries. Inheritance taxes are charged on the value of the property you inherit, usually after estate taxes have been assessed. It can be challenging to understand how the two different taxes are assessed and paid, so consult a qualified tax attorney if you have questions.
When Do I Need to Pay Taxes on an Inherited Home?
If you sell the house that you have inherited, you will need to report the sale proceeds to the IRS using a special form. It's usually best to fill out the form, even if you don't make a profit from selling the home (i.e., you sell it for less than its value). If you make less than the home's fair market value from the sale, you may qualify to take a capital loss on your taxes. These are paid when you file your annual income tax and do not need to be paid immediately upon the sale.
What Are Capital Gains and Why Do They Matter?
As part of selling an inherited property, you'll need to understand capital gains taxes.
Capital gains are the profits made when an investment is sold. To elaborate on our earlier example, if your parents purchased real estate many years ago for $50,000, and it is now worth $500,000, the difference is taxable by the federal government. (There are exceptions for people who sell their primary residence; if your parents were alive and lived in the home before selling it, they wouldn't have as large of a tax burden under the home sale tax exclusion. Capital gains taxes are set according to your taxable income.
Fortunately, for many people in situations like yours, something called step-up taxes can help shield you from Uncle Sam reaching into your wallet. This means taxes are calculated based on what the home is worth at the time of the original owner's death, not what he or she paid for it many years ago. You will only pay taxes on the difference between the value of the property when you inherited it and when you sold it.
Tax law can get complicated, so it's a great idea to work with a tax attorney or knowledgeable real estate attorney to determine your exact financial obligations to the IRS. At Weeks Auction Group, we have a strong network of tax attorneys that can make the process easier for you.
Common Real Estate Tax Terms
It may help you to understand your tax responsibilities better if you know the meanings of some related terms that you're likely to run across as you consider selling your inherited home.
The tax basis is the amount of value you'll be taxed on. The stepped-up basis rules let you pay tax only on the amount between what the house was valued at on the date you inherited it and the price you sell it for.
Capital Gains Tax
As previously mentioned, capital gains refers to the amount between what you paid for an asset and the current value price. The rate depends on your tax bracket, and the amount depends on how much you can reduce your capital gains by figuring in capital losses from other assets.
When you sell an asset for less than its value, you take a capital loss. It's basically the opposite of capital gains. If you have capital losses on some assets, any capital gains can be offset by the losses.
These are the costs you pay when you sell a house. They can include escrow fees, attorney costs, recording or survey fees, title search costs, taxes, and other associated mortgage fees. Some closing costs are carried entirely by the buyer, but sometimes the seller will have closing costs to pay.
You pay property taxes every year on the real estate you own. The amount can vary from state to state, county to county, and even city to city. The amount of tax is usually based on the property's assessed value.
The estate tax is paid on the value of a deceased person's assets at the time of death. These usually come out of the estate before assets are divided among those who inherit the property. Spouses don't have to pay estate taxes.
Fair Market Value
Fair market value is the amount that a property is worth today to buyers. It's usually determined by looking at comparable properties and what they have recently sold for.
FAQs About Inheriting a Home
You may have more questions about inheriting a home, so we want to provide answers to some of the more frequently asked questions we hear.
What happens when I inherit a house?
You'll need to decide whether you'll be moving into the home, renting it out, or selling it. If you are selling it, you may have a lot of work to do to move out personal belongings from the previous owner. Then, you'll have to set a purchase price and put the home on the market — perhaps in a market you're not familiar with or don't live near. Working with an auction group like Weeks can help you ease the burden of managing the sale of an inherited house on your own.
If I inherit a home, do I qualify for the home sale tax exclusion?
No, the home sale tax exclusion only applies to homeowners who have lived in the house for at least two of the past five years and consider it to be a primary residence. However, you can take advantage of stepped-up tax rates that only place a tax burden on the increase in value between the time you inherited the property and the time you sold it.
Should I sell my parents' house?
It can be challenging to decide whether to sell a home that your parents — and possibly you at an earlier time — lived in, enjoyed, and made great memories in while living there. Only you can decide what to do, but selling can be made easier by working with a team that can help prepare the home for sale, value it correctly, walk you through the selling process, and transfer ownership to another family member or individual.
How long do I have to sell an inherited house?
In most states, there is no obligation to sell an inherited house right away. You'll have to go through probate, which can take up to several months, and you will need to prepare the home for sale. Each state has different laws that apply to the probate process, so you'll need to take those into account when deciding on the best timeline for selling inherited real estate.
How do I calculate capital gains on inherited property?
Capital gains taxes on inherited property are calculated based on the difference in value between the cost of the home when you inherit it, and when you sell it. If you choose not to sell the house right away, you will not have to pay capital gains until you do. At that time, if the home has become your primary residence (you've been living there more than two of the past five years), you may qualify for the home sale tax exclusion. But to know for sure, we advise working with a qualified tax attorney.
How Do I Move Forward in Selling an Inherited House?
If you've decided to sell your house, it can be much easier to let an expert work with you to get the maximum sale price with the least amount of time and effort on your part. An established professional group like Weeks Auction Group can step in to help you organize and sell possessions and property, using a plan that's customized to your situation and current needs. With more than 60 years of experience, our real estate pros can provide a complete solution to remove the hassle and overwhelm from your plate. Contact us today to learn more about our services and get the assistance you need.