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Financial Considerations After Inheriting a House

Inheriting a home, such as the family home or a vacation home can be emotional. As you begin to sort through the emotional and practical issues, you may initially be left with more questions than answers. As an added complexity, it is quite common for the remaining parent to leave a home to all the children. Varying wishes for the property can test family relationships and prompt unwise financial decisions. If you have inherited a home or expect to, it is important to know your options and have a practical plan in place for the property before the stress of losing a loved one.

What to do with an inherited house

After inheriting a house (or even beforehand, should you already know the homeowner's wishes), begin to assemble the objective facts of the inherited property. The executor of the estate should have access to any questions you cannot answer. This checklist will help you organize your thoughts by providing a clear factual basis for you to come back to as needed.

Inherited Real Estate Decision Guide

How inherited real estate is taxed

Financial Considerations After Inheriting a HouseThe tax treatment of an inheritance and inherited property such as a home or vacation home receives a "stepped-up" basis for tax purposes. This
stepped-up cost basis is the market value of the property at the date of death. This stepped up value is always considered long term for capital gains taxes. If you sell the property for more than the cost basis, the gain will be taxed at long term capital gains rates.

If the property is sold for less than your stepped-up basis, it will likely be considered a capital loss. Only $3,000 in capital losses may be deducted against your income each year. However, the balance may be carried forward to future years. These calculations can be complex; consulting a tax professional for specific advice is advisable.  

Options for an inherited home

1. Sell the inherited property

Each family will have different reasons for deciding to keep or sell inherited property. Many decide to sell the house for the following reasons:

  • Financial reasons: Put simply, the sudden ownership of a home (whether a first, second, or even third home) is not financially feasible for most families. Even without a mortgage on the property, insurance, taxes, and maintenance costs can be significant on some homes. If the home does have 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 or vacation home) may require you to use home equity or get a new mortgage or refinance
  • Limit taxable gains: Due to the favorable step-up basis for tax purposes, your tax exposure may be limited if the sale is made quickly. Real estate markets can be volatile, so it may make sense to sell after consulting a real estate agent if the market is up.
  • Other competing goals: With finite resources, it may not be possible to own an inherited property given your other goals and financial obligations. Selling the home and using the proceeds to develop an investment management strategy to help fund other goals, such as retirement, education, or a bucket list vacation, eliminates the market risk of holding real estate.
  • Family ties: Even plans that begin with the best intentions can end with disastrous outcomes. Different financial situations, lifestyles, and personalities often create conflict. Compromising over use of the home during desired vacation times and deciding who will bear the primary burden of managing the property are also common sources of tension. 

2. Keep the inherited home

It is often difficult to part with a family home. For those with greater financial means, the good news is that keeping the home may be an option. The following are some common reasons beneficiaries keep an inherited home:

  • Financially feasible: First and foremost, you have to be able to afford the expenses associated with the home or be willing to make any necessary lifestyle adjustments to do so. Certainly your loved one would not want to put you in a precarious financial situation by leaving you the property, so it is important to keep things in perspective. 
  • Nostalgic reasons: After the passing of a loved one, it is difficult to deal with the inevitable changes. Whether you decide to keep the property for a trial period at first or move forward with long-term plans is up to you.
  • Real estate investment opportunity: The local real estate market will determine the strength of this strategy. Perhaps the property is located in a year-round vacation destination or there are plans for development which you expect will increase the value of the home. You will owe capital gains taxes on the gain when you sell, but 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. 

3. Donate the inherited house

A less common option for the inherited property is to donate it to a qualified charity for a tax deduction. Although the specifics of how this strategy may benefit you should be discussed with a tax professional, common reasons for donating the home are:

  • Charitably inclined: Whether you have a particular organization in mind or plan to donate  in memory of your loved one, the desire to give is often the main objective.
  • Tax deduction: Although it will depend on the specifics of the property and your situation, you may be able to deduct a portion of the fair market value of the property against your adjusted gross income (AGI). The remaining value that cannot be deducted in the current year can be carried over for five years.

After inheriting a home, try not to rush into a decision, particularly if there are other beneficiaries. Your financial advisor can help you with the affordability aspect, but you and your family will need to make sense of the emotional side of the decision, undoubtedly the hardest part. 

If you're trying to decide what to do with an inherited property, Darrow Wealth Management may be able to help. Contact us today to schedule a free consultation.

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