It’s hard enough to manage the grief of losing a loved one without dealing with the costs of inheriting their house. We understand how confusing the financial aspect of inheriting real estate can be. We hope to make this challenging time a little easier by bringing awareness to the hidden expenses that may arise. So, what does it cost to inherit a house?
If a loved one left you a property, one of the first questions you may have is: Do I have to pay taxes on a house I inherited? It is possible that inheriting real estate may result in tax consequences. However, how much you owe depends on your location and the value of the property you inherit.
As the person inheriting a property, you do not pay estate taxes. The estate itself pays estate taxes. However, depending on your state, you may owe an inheritance tax. Though the federal government does not impose an inheritance tax, several states do. The inheritance tax states are:
- New Jersey
For example, the inheritance tax in Maryland is 10% of the value of the property you inherit. However, if you are a direct relative such as a child, spouse, or sibling, you are exempt from the tax. If you live in one of the states mentioned above, be sure to review the specific rules and exemptions.
Capital gains taxes
Capital gains taxes are another type of tax you may owe on an inherited property. Capital gains taxes apply to any investment (such as stocks, bonds, real estate, or other assets) that increase in value from the original purchase price.
If you inherit a home that has increased in value since the original owner purchased it, you may have to pay capital gains taxes. However, a special tax rule for those who inherit real estate may save you from a hefty tax bill — known as the “step-up” rule.
What is the step-up rule?
The IRS allows you to use the step-up rule to calculate your capital gains tax liability when you inherit a property. Let’s say you inherited your parent’s home that they purchased in 1980 for $100,000. On the day you inherit the house, the value is $300,000. Under ordinary tax rules, you’d have to pay capital gains taxes on the difference between what your parents paid and the current value — $200,000 in this case.
The step-up rule allows you to calculate your capital gains tax from the home’s value when you inherit it. This drastically lowers your tax bill as the value of the inherited property likely won’t fluctuate much between the day you inherit and when you sell — which is why it’s important to sell the house quickly.
Unpaid mortgage balance
If you inherited a home, one of the first things to check is whether a mortgage is attached to the property. The financial status of the house may determine how quickly you decide to sell or rent the home, so it’s crucial to gather this information as soon as possible.
If there is a mortgage on the home, be sure to review the repayment terms. For example, is there a due-on-sale clause requiring you to repay the loan in full upon the original owner’s death? In this case, you will need to come up with the cash or sell the home immediately to pay off the loan.
If you inherited from a family member, you might be able to “assume” the mortgage payments instead, meaning you take over repayment of the loan. It’s crucial to contact the lender soon after inheriting the property to review your options.
Another unexpected cost of inheriting a home is repair work. Whether you plan to keep, sell, or rent out the property, repairs may be necessary. If you plan to sell the property, many buyers prefer move-in-ready homes. This is particularly true if the house needs extensive repairs such as foundation or electrical work. Since they are relatively quick fixes, potential buyers may be more willing to look past cosmetic issues such as cracked paint or old carpets.
Similarly, unexpected costs can quickly add up if you decide to rent out the property. As a rental owner, you have to make sure everything is up to code and be ready to cover the cost of repairs. Additionally, if you live in a different state, you may be required to hire a local property management company to be on call to handle maintenance requests.
Real estate commissions
Whether you decide to sell or rent out the property, you will need to hire a real estate agent to help you find buyers or tenants. Real estate agent commissions vary based on your location but are typically 5-6% of the home’s sale price. Depending on your local market, agent fees can easily result in a $2-$3k bill for rentals.
Some people may choose to avoid real estate agent fees by selling or renting out a property themselves. However, a good real estate agent can help you price the home correctly and take a lot of the work off your hands, such as finding buyers or interviewing potential tenants.
Holding & maintenance costs
If you want to turn the inherited property into a rental, you must be prepared to stay on top of ongoing maintenance — both preventive and one-off repair requests. It’s a good idea to do a walk-through with an inspector once a year to ensure everything runs smoothly. This also allows you to monitor the property’s condition and address any tenant concerns.
The costs of inheriting a house will vary significantly depending on whether you choose to sell or rent the property. Before choosing one option over the other, it’s essential to consider the costs of each and determine what is the most financially feasible.