The idea of owning another home may be attractive, but does it make financial sense?
By Kristin McFarland
Before deciding to keep an inherited home, take a close look at the other issues and financial questions involved. (GETTY IMAGES)
Receiving an inheritance is often an emotional experience. Inheriting property, such as the family home or a vacation home can be especially trying, as you weigh decisions that have both emotional and practical considerations.
It is also common for the remaining parent to leave a house to all of their children. Depending on the family dynamic and the varying wishes for the property, it may be more difficult to reach a consensus.
Selling an inherited home. As you consider the option to sell the inherited property, it is important to understand how the transaction will be taxed. When you inherit property such as a home or vacation home, the basis for tax purposes is the market value at the date of death. This stepped-up value is always considered long term for capital gains taxes. If the property is subsequently sold for more than the stepped-up basis, the gain will be taxed at long term capital gains rates.
If the property is later sold at a loss, it will likely be considered a capital loss. Up to $3,000 in capital losses may be deducted against your income each year, but the balance may be carried forward to future years. It is advisable to consult a tax professional for specific advice related to your situation.
Benefits of selling an inherited home. Each family will have different reasons for deciding to keep or sell inherited property. For many, the benefits of selling the house are as follows:
- Affordability: Most individuals cannot afford to suddenly take on another home. Even if the home is paid off, there are the costs of insurance, real estate taxes and maintenance. If the home has a mortgage the analysis becomes more complex. Although relatives are allowed to keep the existing mortgage, how you plan to use the inherited property (e.g. as a rental) may require you to get a new mortgage or refinance.
- Protect gains: Due to the favorable step-up basis for tax purposes, your tax exposure may be limited if the sale is made rather quickly. Real estate markets can be volatile, so it may make sense to sell after consulting a real estate agent.
- Diversify for other goals: Owning and maintaining inherited property is not typically a financial goal for many individuals. Using the proceeds from the sale to fund other goals, such as retirement, education, or a bucket list vacation, eliminates the market risk of holding real estate while saving for your other objectives.
- Preserving family relationships: Sharing a home with adult siblings doesn’t always work out the way it was intended. Large income disparities between siblings may create conflict as unexpected expenses arise and cannot easily be paid for. Compromise can be challenging when negotiating use of the home over desired vacation times. The burden of managing the property is likely to rest on one person. If no one is willing to step up, it may be best to sell.
Before deciding to keep the house, take a close look at the other issues and financial questions involved. What will your mortgage be? What are the taxes, insurance, and maintenance costs? What is the real estate market like in the area? Will you rent the home or use it? Do you live close enough to handle ongoing maintenance or will you need to hire someone?
If you plan on owning the home with other family members, try to evaluate it like any other business decision. Should someone’s financial situation change – will another family member buy them out or will you sell the property (perhaps at a loss)? Who will be responsible for the upkeep of the property? How often will each person wish to use the home? If you would like to use the property as a vacation rental to help offset the expenses, who will be responsible for the logistics?
When multiple beneficiaries (usually siblings) inherit a home, there’s often mixed consensus about what to do with the property. Most commonly, one sibling will buy the others out. This is much easier to facilitate if you have the cash on hand to do so. If not, you will likely need to explore a cash-out refinance if there is sufficient equity in the home.
A cash-out refinance will turn the home’s equity (current market value less the mortgage balance) into cash, which will be used to buy out the other beneficiaries. The equity you receive in cash will be added to the existing mortgage and refinanced. This leaves buyers with a much larger mortgage payment.
If you find yourself struggling to convince your practical side of the merits of keeping the home, take a step back and ask yourself:
- Would I like to own a home in this location at this price point if it were not passed down to me?
- Would I go into business with my co-beneficiary family members?
- Do I have sufficient cash flow or other liquid assets to cover the additional ongoing expenses and maintain a safety margin?
- How will owning this home impact my lifestyle, both financial and otherwise?
- What is my short and long-term plan for this property?
- Will using the home as a rental be worth the additional wear and tear?
- Has the real estate market in the area been relatively stable? Do you expect prices to rise considerably in the future?
- Nostalgic reasons: After the passing of a loved one, it is difficult to deal with the inevitable changes. Keeping the property in the family may help preserve your memories and provide comfort during this time.
- Investment: Depending on the location and condition of the property, it could be a good investment if the local real estate market is strong. Although you will owe capital gains taxes on the gain when you sell down the road, the stepped-up basis will help to limit the tax liability.
- Legacy: Some homes have been in the family for generations. Continuing the tradition may be an important estate planning goal.