Take these concrete steps to minimize expenses when inheriting property — so you can enjoy your inheritance.
Whether you’re inheriting your childhood home, the family vacation house, or a portfolio of rental properties, you’ll inherit more than childhood memories or a beloved family getaway spot. You’ll also inherit expenses that could be unexpected or greater than expected.
But that doesn’t mean you can’t minimize the costs of inheritance. Here’s how to tackle these six considerations when inheriting real estate.
1. Estate Taxes
Federal estate tax applies when an estate’s value, including real estate, exceeds a certain threshold, which you can find on the IRS website.
True to its name, the estate tax comes out of the estate before you take ownership of inherited property. That means your property would only be affected if the estate lacks sufficient liquid assets to pay estate taxes. If the estate is short on cash, the properties may need to be liquidated. Depending on where you live and the property’s location, you may also be required to pay state inheritance tax — which comes out of your own pocket — for the portion of the estate you inherited.
2. Appraisals
A real estate inheritance usually requires a valuation, though it’s not usually a major cost to the inheritor. “Generally, the executor may pay for the cost of an appraisal from current estate proceeds, so it’s usually of little cost or concern to the beneficiary,” says Bryan P. Koepp, Senior Vice President and Wealth Strategist with Regions Private Wealth Management.
Most often, you’ll want a valuation so that the basis of the asset is “stepped up” to its fair market value at the time of the owner’s death or alternate valuation date. This will adjust the value to include any improvements made to the property prior to the decedent’s death. If you sell the property, the sale generates taxes only for gains following the step up in basis valuation, not from the initial date of purchase, which might have been decades prior.
3. Maintenance
If you decide to keep the property and rent it, remember maintenance and overhead can take a big bite out of profits. Landlords are required to hold insurance policies, which can cost as much as 25 percent more than a homeowners policy for the same property.
Maintenance requirements depend on property type and other factors. Often, money is set aside in a trust to cover maintenance an insurance, at least until the transfer of the deed.
In any case, it’s important to protect the asset’s worth by keeping it insured, in good repair, and—whether it’s a commercial or residential property—tenanted.
4. Utilities
Homebuyers often ask previous owners for a year’s worth of utility bills for budgeting purposes, and it’s wise to do the same when you’re inheriting real estate. You may be surprised how much it costs to heat a vacation house or an old family mansion.
You might find opportunities for capital improvements, such as installing new windows. “These updates may lower your utility bills and qualify for tax credits,” Koepp says.
5. Property Taxes
Property taxes vary by locality, and can make a big difference in what you’ll pay.
If you inherit a Gulf Coast vacation home in Mobile, Alabama, you’ll find property tax rates change significantly 60 miles west in Biloxi, Mississippi, and 60 wiles east in Pensacola, Florida. These seemingly small differences can equal thousands of dollars in additional annual property taxes.
“Get in the habit of setting aside a certain amount per month to put toward property taxes,” Koepp says.
Capital Gains
The step up in basis discussed earlier will reduce most capital gains to zero. However, if the taxpayer rents the property for a time, the value may increase. In this scenario, selling the inherited property may subject you to capital gains taxation.
However, if it’s an investment property, consider an allowance called a 1031 like-kind exchange. This gives you the option of selling the property and reinvesting the proceeds into a similar property, without incurring capital gains tax.
No matter what you decide to do with inherited real estate, Koepp says it’s important to have a strategy in place years before you inherit the property. Knowing the rules and regulations ahead of time will help you understand the costs involved and how to minimize them.
While inheriting real estate may bring about difficult conversations with family, ultimately the inherited real estate should bring you happiness, not headaches. Talking about possible problems beforehand can give everyone involved some peace of mind. Whatever course of action you take, decisions should not be made lightly.
Talk with your Regions Wealth Advisor to help weigh your options and identify your goals for the inheritance.
