THE REAL DIRTT: Inheriting Property Can Be a Taxing Time … by Colleen Bennett

August 23, 2017
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I get asked all the time by heirs about what they should do upon inheriting a home: Should they sell, rent or move into it?
Let’s briefly take a look at each option:
Selling. In many ways, this is the easiest option, especially if other family members are involved. You put the house on the market and put the money in your pocket or split the proceeds after the sale with your co-heirs. Psychologically, the sale represents a clean break from the past, you’ve cleaned house. You now have an opportunity to invest your inheritance any way you choose.
The tax code also treats sales favorably. Any capital gains you might incur are treated on a “stepped-up” basis, meaning Uncle Sam bases your gain on the value of the home at the time of your parent’s death, (say, $1 million), not what the parent originally paid for it (say, $250,000 in 1985). So, if you were to sell the inherited home next year for $1.1 million, you would pay capital gains only on the $100,000 — your personal gain or appreciation of $100,000 after inheriting the home.
When you inherited the home, the fair market value or “new cost basis” was $1 million, after which you realized a $100,000 gain.
Of course, you will need a Realtor or an appraiser to help you establish the time-of-death value, although interestingly, the valuation can be made retroactively, usually up to a period of six months. In other words, Uncle Sam has a heart. He understands that lots of details and concerns have to be addressed when a parent passes, and getting your inherited home’s value properly documented might not be at the top of the list. Still, rules are rules and the longer you wait, the math gets fuzzier and memories get murkier, so don’t let this chore linger too long.
More good news: If you should realize a gain upon your sale, which is treated as a long-term capital gain (a gain realized over a year or more), rates on those gains top out at 20 percent for the highest-income tax payers. That’s a big break from the nearly double (39.6 percent) rate you otherwise would pay if you were in the highest tax bracket.
Renting. First off, renting buys you some time. If you’re on the fence about selling, renting gives you time to consider your options. You could rent for a year, then sell. Renting also could provide you with income every month, which could allow you to contribute more to your retirement savings, fix up your own home or simply live a little more comfortably with regard to eating out, traveling or other indulgences you’ve rationed or budgeted for in the past.
Still, no lunch comes completely free. You would still have to get the property ready to rent and continually maintain it, and then there’s the human element of finding a tenant who isn’t going to run your nest egg into the ground (dogs, oil-leaking cars staining your new pavers, etc.). And if one renter moves out, you may have to endure periods where you don’t collect any rent until another renter moves in.
You can avoid many renting hassles simply by hiring a property management company to vet tenants and maintain your property, but expect to pay between 8 percent and 12 percent for the privilege.
Moving in. If the home provides you an opportunity to live in a neighborhood you might not otherwise be able to afford, you might consider moving into the home. If you choose this option, plan on living in the home for at least the next two years. That’s because if you live in the home for this period of time, the tax code allows you to exclude any capital gains up to $250,000 for individual taxpayers and $500,000 for married couples filing jointly. So, if the fair market value of the inherited home you moved into was $1 million, in our above example, and you and your spouse (who file jointly) sold it three years later for $1.4 million, you would pay no capital gains.
Whatever you choose, don’t rush any decisions. With time, family matters (and occasional drama) have a way of working themselves out. That said, it’s always good to know you have clear options.
Colleen Bennett is a leading Southern California Realtor (DRE#01013172) with Sotheby’s International Realty who makes her home in La Verne, Calif. If you have any type of real estate question you would like help in addressing, you can reach her at 626.344.0907. With any financial matters, especially tax issues, rules and limits, which can change often, always consult your attorney or tax adviser for the most current information. The information provided is offered as a community service and for discussion purposes only.

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