Inheriting a property can feel overwhelming for many individuals. Here’s what to consider before you decide to keep, sell, or rent it out.
Congratulations on inheriting a property! While this may be an exciting development, it can also bring a wave of uncertainty, especially if you’re not a current homeowner or lack experience in property management. This inheritance likely comes as a result of a family member's passing or a transfer within the family. Regardless of your feelings about receiving this property, you’ll need to make some important decisions about its future.
When you inherit a home, here are a few initial considerations:
What are the financial obligations tied to this property, and can you manage them?
How will owning this property impact your taxes?
What is the best course of action for you and your family? Will you choose to sell it, rent it out, or move in?
If you share ownership with another family member, some of these choices may be more complex. We’ll explore the steps you can take later in this article, along with an overview of financial obligations, tax implications, and your options: renting, selling, or keeping the property.
Financial Responsibilities of the Property
Your first step is to assess the property’s financial situation, particularly if there is an outstanding mortgage. Generally, you can assume the mortgage and continue making payments, but be aware that some loans may stipulate that the balance is due immediately upon the mortgage holder's death. This can lead to the necessity of selling the property quickly.
Another critical aspect to evaluate is the home’s condition. Has it been well-maintained over the years, or does it require significant repairs? Home repairs can accumulate quickly and are often necessary whether you plan to rent or sell. If you’re unsure about the extent of any damage, it may be wise to hire a professional inspector. This assessment will provide clarity on the home’s condition and help you preemptively address any issues before renting or selling.
If you decide to keep the home or rent it out, ongoing maintenance will be essential, so keep this in mind as you consider your options.
Tax Considerations
Capital Gains Tax
Capital gains taxes apply to the profit made from selling an asset, and this includes real estate. When inheriting a property, it must be reassessed at its fair market value (FMV). Taxes will be calculated based on the difference between the FMV at inheritance and the sale price.
For example, if your family purchased the home for $40,000 in 1975, but the current FMV is $500,000, your new tax basis becomes $500,000. If you sell the home for that same amount, no capital gains tax will be owed. However, if it sells for $575,000, you would owe taxes on the $75,000 profit.
There is also a capital gains exclusion available if you live in the home for a specified period before selling. If you reside in the home for at least two of the five years preceding the sale, you could exclude up to $250,000 of gains from your income ($500,000 for married couples). This exclusion can only be claimed if you haven’t already utilized it on another residence within the past two years.
California's Proposition 19: Effective 2021
As of early 2021, Proposition 19 in California changed the rules regarding property tax benefits for heirs. Under this law, children who inherit their parent’s or grandparent’s home no longer receive a tax break if they use it as a second home or rent it out. The option to transfer up to $1 million of assessed value that isn’t a primary residence was eliminated.
Currently, properties can only be transferred without reassessment if the beneficiary plans to use the inherited residence as their primary home, or if the FMV at transfer does not exceed the assessed value by more than $1 million. This law also does not apply to properties held in LLCs or other legal entities. It’s wise to consult with an attorney regarding these regulations and your property options.
Inheriting with Multiple Heirs
Inheriting property alongside siblings or relatives complicates matters further. You’ll need to come to a consensus on the best course of action. If an agreement cannot be reached, consider the following options:
Buy Out Other HeirsIf one heir wishes to keep the property, they can propose buying out the others.
Promissory NoteIf you want to retain the property while another heir prefers to sell, a promissory note can be created. This legal document outlines a promise to pay a specified amount to another party, either at a fixed future date or on demand.
Rent and Share ProfitsIf keeping the home in the family is a priority, suggest renting it out and splitting the profits. This can create passive income and allow for the option of selling or moving in later.
Partition LawsuitIf all parties cannot agree, the last resort is to file a lawsuit for partition, forcing the sale of the property. However, this route can be expensive and detracts from potential profits, so it’s best to avoid it if possible.
Your Choices
Move In
One option is to move into the inherited home yourself. This can be a wonderful opportunity, especially if you’re not currently a homeowner or are looking to downsize from another property. However, ensure this decision aligns with your financial situation. If the mortgage is affordable, moving in might be a great way to keep the property within the family. If there are multiple heirs, discussions about who will reside in the house may need to take place.
Rent It Out
If moving in isn’t an option, renting the property is another excellent alternative. This allows you to maintain ownership without needing the home for personal use, and it can help cover expenses related to your own mortgage.
Depending on the market, the home may be located in either a cash flow or appreciation area. Cash flow markets provide immediate rental income, while appreciation markets increase the property's value over time, yielding more upon sale.
Becoming a landlord can seem intimidating if you lack experience, but there are many resources available to help you navigate the process of renting and managing tenants.
If the idea of managing the property seems too overwhelming, consider hiring a property management company. This option allows you to retain ownership without the day-to-day responsibilities.
Note that if you choose to rent the property, you won’t qualify for the capital gains exclusion; however, there are tax benefits to consider, such as lower tax rates on rental income.
Sell It
If you prefer not to keep the property, selling it is a viable option, especially if you and your family members have no desire to retain it in the family. While selling can provide quick cash, be mindful of associated costs, including agent commissions, closing costs, and any debts tied to the property. You may also want to make some repairs or upgrades to enhance the home's appeal, but be cautious not to over-improve beyond what the neighborhood can support, as this may hinder your ability to sell.
Research your local market to gauge the best selling conditions. In Santa Cruz, for instance, understanding the trends can help you sell your property efficiently.
Conclusion
Inheriting a property comes with numerous decisions and responsibilities. If maintaining the home within the family is a priority, you might consider moving in or renting it out temporarily. On the other hand, if immediate cash is more appealing, selling could be the best path.
Always consult with a legal or financial advisor before making significant decisions regarding an inherited property.
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Logan Andren
Logan Andren is the founder and CEO of Andren Homes Property Management. Since launching the company, Logan and his dedicated team have simplified the rental property experience for numerous Santa Cruz homeowners. Their mission is to enhance the lives of their clients and community, focusing on providing exceptional service and fostering lasting relationships. DRE #02002055
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