Of all the types of assets, real estate is usually the most emotional. It is, after all, difficult to make memories in a mutual fund (which is a feature of diversified investments, not a bug). So when you inherit a house from a parent, it’s important to recognize the emotional attachment will likely influence your decision-making. Before deciding what to do with an inherited home, consider all the angles and potential outcomes — particularly if you inherited the house with other family members.
Options for an inherited home
Whether you’ve inherited a home by will or as a beneficiary of a trust, you’ll likely have some decisions to make about what to with the property. In most situations, the beneficiaries of an inherited house will choose from the following options:
- Sell it
- Keep the house for personal use or as a rental property
Whether inherited stock or a home, one way to try to separate the emotional element from a major financial decision is to work backwards. If you had the cash in hand, would you use it to buy ‘the thing‘? For example, imagine you inherited cash instead. The money is sitting in your bank account, free and clear. Would you use it all to buy this house?
If the answer is no, then…there’s your answer? But if it’s maybe or yes, keep reading. There are other angles when considering what to do after inheriting a house. But first, it’s important to discuss the tax implications.
Do you pay taxes on an inherited house?
Naturally, the answer is it depends. But typically, after inheriting the family home from a parent, the adult child[ren] beneficiaries will receive a step-up in basis for tax purposes. This stepped-up cost basis is usually the market value of the property on the date of death, though the estate may elect an alternate valuation date (six months after death). This simplified explainer summarizes how most inherited homes are taxed to beneficiaries when they’re inherited by a will or owned in a revocable trust at death (and then distributed to heirs).
The tax benefits of a step-up in cost basis is significant if the property has gone up a lot in value. Also, a step-up is always considered long-term for capital gains tax purposes, regardless of the actual holding period.
Not every inherited home is eligible for a step-up in basis, though. And situationally, even if a home gets this preferred tax-treatment, there are other outcomes that could change the course for your situation. For example, sometimes a home is inherited from a trust that was irrevocable during the decedent’s life. Or perhaps the home (or proceeds) must remain in trust. Or maybe there’s another arrangement that can change the tax implications and options for the beneficiary.
Federal and state estate tax implications are different
Another caveat to keep in mind is that the tax treatment for someone inheriting a home is different from any possible federal or state estate/inheritance tax that may be due. Though separate issues, the estate will still need liquidity, which can impact what assets are available for beneficiaries and the nature of that distribution.
Assume, for example, that an individual died ‘house poor’ with virtually no liquid assets and a multi-million dollar home. In a state like Massachusetts with a low estate tax exemption (recently increased to $2M in 2023), the executor may need to sell the house to pay the tax if the heir(s) don’t have liquidity from other sources. This discussion is outside the scope of this article, but something to consider addressing with the attorney settling the estate.
Deciding what to do when you inherit a house
Option #1 Sell it
When you inherit a house, in many situations, it makes the most financial and ‘family’ sense to sell it. Here are some of the reasons to consider selling the home.
- If you can’t afford it. It may sound obvious, but it’s not always when you’re the one with the emotional ties of the property. Sometimes, heirs go to great lengths (and financial peril) to keep a home they inherit in the family. Add up the property taxes, upkeep, cost of buying out other family members, assuming any debt on the property, etc. If you’d have to deplete your savings or cut back on other important financial activities like saving for retirement, you probably can’t afford it. Real estate is an illiquid asset, so you’ll need outside resources.
- To limit taxable gains. If benefitting from a step-up in basis, you may be able to sell the home fairly quickly without tax implications.
- Because owning a home with siblings is usually not a good idea. Good intentions don’t guarantee good outcomes. Co-owning a vacation home with siblings can be a disaster: different financial means, proximity, lifestyles…can all create conflict. Perhaps there’s a repair and one sibling doesn’t have the cash (or desire to part with it). Homes don’t care for themselves, so time is also a factor, especially if everyone does not or cannot equally share the load. This often happens when one sibling lives much closer than the others, is deemed to have the ‘skills’ (financial, construction, etc.), or is presumed to have free time to manage a rental property. Finally, consider how the shared home will be used and allocated. Who gets weekends in-season or holidays? Does everyone share the costs, usage, and/or rental income equally? Even little things can create tension. Without a written agreement detailing the arrangement, it might be best to sell the home to keep the peace.
- The cost (and effort) to make it what you want it to be isn’t worth it. Is your parent’s house or the family vacation home really move-in ready? Consider the layout, furnishings, rugs, appliances, and the cost of un-doing any retrofitting or installations for safety or mobility issues. The cost of owning a second home is significant and can contain hidden costs. If you’re considering co-owning the home with a sibling or keeping it as a rental, how much time and expense will be involved in readying the property for that use? Do you have the funds to do it? Is it worth it? At some point, you could be better off financially to take the proceeds and buy the property you want to own.
Option #2 Keep it for your use or as a rental
Assuming none of the points presented above apply or concern you, keeping an inherited home could be a good option.
- Unique property. Some homes are truly unique due to their location, subsequent changes to zoning laws, history, generations in the family, etc. If there aren’t any major financial or logistical concerns to address, keeping the home could make a lot of sense.
- Meets an existing financial goal. Perhaps one of your primary financial goals is to purchase a vacation home in the same location. If the house you inherit meets your needs, it might be a cost-effective way of accomplishing your existing objectives.
- Rental opportunity or split use. The local real estate market will determine the viability of this plan. Perhaps the property is located in an attractive year-round vacation destination. Before keeping the home and renting it, speak with a real estate agent to discuss the rental market. If you don’t have the time to manage the rental yourself, run the numbers to ensure the rental income can support a property manager. A potential opportunity here is keeping the house for split use between a rental property and personal use to offset the costs. Keeping the home as a rental might also be worth considering in situations where there’s a need to diversify outside of your investment portfolio.
Before keeping a home you inherit, discuss the numbers with your financial advisor.
Of course they left you the house. That doesn’t mean they want you to keep it
In deciding the best approach, first and foremost consider your financial situation, goals, and needs. Parents often say, I’m leaving the house to my kids, but I don’t care what they do with it.
Estate plans are about distributions, not sentiments. Unfortunately, this lack of clarity is a key reason heirs cling to an asset they would have otherwise sold. Although we encourage homeowners to leave a memo with their estate plan to clarify any wishes for the property, few people receive guidance from the grave in practice. So when considering what to do with an inherited house, make sure the decision aligns with your financial circumstances and lifestyle. And remember, just because they left it to you, doesn’t mean they wanted you to keep it, too.
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