Taxation and Inherited Houses
Hello and welcome to Real Estate Problem Solver. I’m your host, Chris. In today’s episode, we’re going to be talking about inherited properties and the taxation of those inherited properties.
I know this is going to be kind of a tacky subject because this is involving an emotional event where a loved one has died and the estate is getting passed on to their son, daughter, significant other and loved ones. And so, a lot of people don’t want to approach this subject, but it is a necessary evil in order to make sure that 1) the deceased, their wishes are carried out and 2) what they intended to pass on to their loved ones, to you, are getting taken care of properly.
My personal experience with inherited properties when my parents died, they didn’t take care of the will the way they’re supposed to. They didn’t leave orders in the proper fashion so everything got straightened out to satisfaction, but it definitely could have been done much better.
That pretty much falls on the parents who, of course, are going to be more apt especially if they’re old school like my parents were. Mom and dad didn’t think too much about their death because, of course, they’re going to be immortal and kids are singing and not heard. So, they have no business getting into mom and dad’s finances or know anything about mom and dad’s finances. So, have that talked with your parents please. You know it’s a sore subject but it’s better to go ahead and make plans before it’s too late than trying to figure it out after it’s too late.
So, on with the show. When loved ones die, the assets in their estate are going to be handled by an executor. Now, I am not a tax attorney or I’m not an attorney. This is just for educational purposes. I’m just going to put that out there. It’s a disclosure. We’re going to be touching the surface. For more information on this, do contact a probate attorney to get more details. A tax attorney could definitely help in setting up and planning the transfer of an inherited property.
But when a loved one dies, everything that the deceased owns will get put into an estate as kind of a living trust of sorts. You’re going into an estate and the first thing that happens is anybody that the deceased owes money to will get paid. Now, if there’s not enough money then they’ll start selling assets in order to pay off those debts. So, that’s why it’s important for them to make sure if you’re the one that’s up in years then make sure that you keep your debts to a minimum.
Now, the house itself. When a house is going to be passed to a loved one who decides that they want to sell it; even if it’s multiple people that are inheriting the house, brother and sister, sister and mom; of course, they had to be all agreeable or the will has to direct the actions specifically.
If the house is to be sold, the house will be sold usually on the open market or unless somebody that you know of wants to buy the house right off a probate, which is something that we do at Real Estate Problem Solver. We will actually coordinate with the probate attorney or the probate judge or the executor. And if there’s a house in the estate that needs to be sold, we will go in and we will make an offer, and try to expedite the probate process.
Now, when the house is sold, the first thing that they should do is to get an appraisal, get an evaluation of what the fair market of the house is at the time of the loved one’s death. According to the IRS regulations, there are two different dates that they use. Either consistently across the board, they use the date of the deceased’s death or they consistently across the board use an alternate date. Now, you’ll have to talk to your tax attorney or probate attorney to decide on which one you’ll want to use and why. You can use the date of the deceased’s death or the alternate evaluation date. Ask them about that. But whichever way you go, the value of the house will be based on a certain date, how much it’s worth at that certain date.
Once that is on paper, say for example the house is worth $100,000. So, if the house is worth $100,000 at the time of the loved one’s death, then the basis of the house, no matter what they bought it for, it doesn’t matter what they bought it for anymore.
When it passes to the heirs, the value of the house, the basis of the house jumps up to the new value. So, if dad bought the house for a dollar and it’s now worth $100,000, there’s $99,000 of equity that he would be taxed on. If dad dies and the house is passed to the son, the new value of $100,000 is the new basis, so dad would get taxed on $99,000. But when he dies and it gets passed to the son, the son can sell it for $100,000 and not paying tax at all. As a matter of fact, if he sells the house for less than $100,000, he can take a tax loss.
So, keep that in mind, heirs out there. If you inherit a house and you make a lot of money, you’re going to get taxed on that money, right? It’s income money. Everybody pays it. But if that $100,000-house is valued at $100,000, and mom and dad dies and passed it to you; if you sell it for less than $100,000, say you sell it for $80,000, you have a $20,000 loss that you can use to offset the other income that you have already made. Your other income tax will be offset by that $20,000 loss.
So, you can gain $80,000 in your pocket and get a $20,000 loss on your taxes. Or you can sell it for $100,000 and pay nothing, and you still pay the taxes on your other income. Or you can sell it if you can sell it for more than its worth $120,000, but now you’re going to pay income tax or capital gains—it’s capital gains because it’s an asset—then you’ll pay taxes on the $20,000 plus whatever other income you may have.
So, long and short. When you sell a house, the basis would jump up to the value of the property at the time of the owner’s death. And then, the new inheritors have a new basis of that new fair market value. Now, tax-wise, that’s a good benefit. Unfortunately, it requires the death of a loved one to acquire that kind of tax benefit.
But, you know, if the inheritors are in need of some money to pay off bills or get out of problems and the house isn’t something that they really want to hold on to, then that would be a good way to pay off bills in a fast way. For us, that’s why we do that in order to expedite the sales process. Because the longer a house sits, the more an empty house becomes damaged or start leaking or it grows mold.
A house is better maintained when it’s lived in
So, for people who inherit a house, I implore you that the best way to take care of an inherited house is to occupy it. Occupy it, use it and visit it. Turn on the lights. Turn on the ceiling fans. Walk around the house. Turn on the air conditioner. Use the house. Mow the grass.
This is kind of stepping out of the taxation. Forgive me, but it’s just another possible article or addition that I need to add to our series. But take care of a house that is empty or use it. Of course, being a rented property is a possibility, but some people are not apt to be landlords. So, the best bet would be to go ahead and sell it to someone who is going to use it.
We have actually run into a lot of people who have called us and asked us to buy the property that they inherited from a family member. Unfortunately, the family member died two or three years ago and they haven’t done anything to the house. They haven’t even been in the same state. They’ve just let it sit. So, when I go to look at the house, there’s a tree on top of the house or there’s grass growing up through the driveway or concrete cracks. There are squirrels living in the attic. The spiders have taken up residence in the garage or in the crawlspace. Just all kinds of things that an empty house is going to collect.
So, of course, we can’t buy the house for as much as we normally could because we have to fix all these. We have to declutter the house. We have to clean the driveway. We have to mow the grass. We have to cut the trees. We have to pull the tree off the roof. We have to fix the roof or to replace the roof. So, when things happen that involve an inherited house, make sure to take care of those necessities in a timely manner.
As for the taxation, it’s pretty cut and dried. Once the person that owns the house dies and it’s inherited by the family member, then the basis in which they bought the house jumps up to the new fair market value at the time of the death. So, if it’s $100,000 and you sell it for $100,000, you have a $100,000 with no taxable event. If it goes for more than $100,000, anything above that mark will become taxable.
So, hope this helps. This is Chris for the Real Estate Problem Solver. And we’ll talk to you next time. Have a good one.