What to Do When You Inherit a House - SmartAsset

Inheriting a residential property like a house marks the end of a life and the beginning of deciding what to do with the property and implementing that plan. The considerations in handling a house inheritance include taxes, financial issues like a mortgage and relationship concerns. While inheriting a house can be a boon financially and emotionally, handling the transaction to best advantage calls for some study and care. If you have questions about the specifics of your financial situation, you may even want to talk to a financial advisor about it.

What You Can Do When You Inherit a House

Three main options exist when a home is inherited by you and your family. Basically, the heir or heirs can choose to occupy it, sell it or rent it out. Here’s a general breakdown of what each choice means:

Occupying the home means it will stay in the family, which can be appealing if there are memories connected with the property. If there is no mortgage, this can be an economical option as well.
Selling the home provides immediate cash, assuming it is worth more than the mortgage after necessary repairs. This can be a relatively quick and easy way to make the most of a home inheritance without adding any future risks.
Renting the home can provide passive income and even some tax advantages. However, becoming a landlord involves costs and coping with tenants can require a lot of time and attention.

Managing Taxes When You Inherit a House

Inheriting a house doesn’t usually trigger any tax liabilities by itself. There is no federal inheritance tax, although larger estates may have to pay federal estate taxes. Six states impose an inheritance tax: Iowa, Kentucky, Maryland, Nebraska, New Jersey and Pennsylvania. In all of these states, a spouse is exempt from paying inheritance tax. Children and grandchildren are exempt from inheritance tax in each of the states except for Pennsylvania and Nebraska. Exemptions vary by state for siblings, aunts, uncles and sons-in-law and daughters-in-law. You will likely face higher inheritance tax rates if you aren’t related to the deceased.

Capital gains taxes may come into play if the heir or heirs choose to sell the house. Capital gains taxes are federal taxes on profits gained on the sale of assets. Short-term capital gains taxes apply on sale of assets owned for a year or less. Long-term capital gains taxes are levied on sale of assets owned for more than a year.

The short-term capital gains tax rate is the same as the taxpayer’s ordinary income tax rate. That is, from 10% to 37% depending on income bracket. Long-term capital gains taxes can be 0%, 15% or 20% depending on income and filing status.

When a house is transferred via inheritance, the value of the house is stepped up to its fair market value at the time it was transferred, according to the IRS. This means that a home purchased many years ago is valued at current market value for capital gains.

For example, a home purchased in 1990 for $80,000 that’s then valued at $400,000 when it’s inherited in 2022 will be stepped-up in value to the latter. If an heir sells it for $400,000, no capital gains tax will be owed since the price is not more than the stepped-up value, meaning no profit was made. But if the heir sells it for $425,000, capital gains tax will be owed on $25,000, the difference between the sale price and the stepped-up value.

If the property is owned for a year or less before the sale, it will be treated as a short-term capital gain. If it’s owned for a year or longer before being sold, long-term capital gains rates will apply.

One more wrinkle in the capital gains tax applies if the heir occupies the home as his or her primary residence for at least two out of five years. Then the IRS may grant an exclusion of up to $500,000 on capital gains taxes for a couple filing jointly or $250,000 for a single filer.

Taking Care of Financial Issues When You Inherit a House

If the home has a mortgage the need to keep making monthly payments has to be considered. Most mortgages can simply be taken over by the heirs. However, if there is a reverse mortgage, a type of home loan available to seniors ages 62 and older, the ownership of the home will transfer to the mortgage company on the death of the owner.

Another issue arises if the house is underwater, with a mortgage balance more than the home’s value. In that case, the new owners may be able to convince the lender to do a short sale, selling the property for less than the loan balance and accepting that amount to settle the debt.

If the home is paid off and has no mortgage, there may still be significant financial considerations if the home needs costly repairs before it can be sold or occupied. Ongoing costs for property taxes, utilities, residential insurance and maintenance costs, including home owner association assessments, also need to be factored in.

Emotional and Relationship Issues

Inheriting a home that has been in the family for a long time can bring emotional and relationship issues to the fore. If multiple heirs were each bequeathed part ownership, it can be trying to sort out what everyone wants and choose a mutually acceptable course of action.

If one person wants to live in the home, he or she can buy out the ownership interests of the other heirs. But if the house is sold, it can be relatively simple to divide up the proceeds among multiple heirs. In order to rent it, the heirs can agree to split the income after expenses.

Heirs often involve a third party such as a family attorney to facilitate discussions and ensure that everyone understands the agreement. Whatever agreement is made, it will normally be put in writing to avoid future misunderstandings.

Bottom Line

Inheriting a house can be a financial windfall as well as a way to keep the site of treasured memories in the family. However, there are a number of tax, financial and emotional considerations to keep in mind when deciding what to do. Much will depend in the size of the mortgage, the home’s value and the costs of upkeep. The issue of taxes should also be carefully studied.

Home Inheritance Tips

If you’ve inherited a home, consider consulting a financial advisor before deciding on a course of action. Finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
In case you are facing a capital gains tax from selling an inherited residence, use a free capital gains tax calculator to get a good idea of what you owe.