Leaving a home for a loved one in inheritance is a huge gift, but without proper planning it can be an equally big headache.
Beneficiaries must deal with a lot of considerations when they inherit a home, especially if they share that gift with siblings or others. They keep or sell the home, the tax has an impact on the emotional attachment to the home and the belongings in the home, as well as other potential estate planning issues.
There is no right or wrong answer when it comes to keeping or selling an inherited home. In some cases, property rents can become a source of income, whereas in other situations, it can be another source of cash after the sale – especially when the real-estate market is doing well. But before you jump in, here’s what to look for:
Impact of home sales tax
People who sell a home after living for two years in the last five years enjoy a discounted tax benefit – for single filers, the exclusion is $ 250,000, and for those who are married it is $ 500,000 to file jointly. This discount is applied when a home is sold to reduce the capital gains that sellers have to pay. For example, if a married couple sells a home for 1 million and has a base of $ 500,000, they will pay $ 0 capital gains tax on that sale. By comparison, if they sell it for $ 1.5 million, they will reduce the tax liability by $ 500,000 and pay capital gains tax on the remaining $ 500,000.
Surviving spouses who inherit the full value of their home after the death of their spouse can benefit from a 500,000 discount even if they sell the home within two years of death, says Peter Palion, a financial advisor and founder of Master Plan Advisory.
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Nonspas should think carefully about when they plan to sell the home. Their foundation of the inherited home becomes fair market value on the date of death of the donor, which means they will pay very little tax if they sell the property in the short term. In comparison, if they sell after many years or decades, they may face a huge tax exposure. For example, if the donor leaves a home after his or her death in 2010, when the fair market value was $ 250,000, and the beneficiary retains the home for another 10 years before being sold for $ 500,000, he or she will be liable to pay capital gains on the difference. (In this case, 250,000).
Beneficiaries should contact a real estate professional who can help determine the fair market value of the home or get a property valuation. “The first thing they need to do is set up the value of the property,” said Jennifer Grant, financial adviser at Periman Financial Advisory. “This small step could pay off many times more in terms of tax savings.”
Soon to be sold vs. keep at home for now
For some, the best strategy for this legacy may be to stop selling, probably because they need time to make that decision. George Reilly, a financial adviser at Safe Harbor Financial Advisors, said in that case, the property would still need to be maintained and secured and taxes, insurance and mortgages would have to be paid.
“Usually, it’s time to evaluate the situation and decide if you want to keep the property and use it or turn it into rental property or sell it,” he said.
If the home still has a mortgage, the beneficiaries should reach out to the lender to see if there is any clause regarding the change of ownership, Reilly said. If existing rates are favorable, they may be able to keep debt instead of refinancing, says Rob Greenman, chief adviser and partner at Vista Capital Partners.
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Working with other beneficiaries
Home inheritance can be more complicated when multiple beneficiaries are listed, especially when children and grandchildren are included. “If there is no agreement, the only solution is to sell,” said Patricia Houseconst, a financial adviser.
Family members can choose from a variety of options, including selling a home and sharing income; House rent and income sharing; Or if a sibling wants to keep the house, such as buying from other owners, or finding ways to trade other assets inherited for the property.
Deciding to own or sell a home can also reduce the likelihood of a successful investment. Will beneficiaries see a good return if they use it as rental income or keep sales income in an investment portfolio? Is the house in good condition, or does it need to be repaired and improved?
“Things get more complicated when the next generation (grandchildren) inherit,” Houseconst said. “There are usually more opinions that make reconciliation more difficult.”