If you’re inheriting a house from a relative, President Biden’s plans to eliminate the stepped-up basis tax rule should concern you. You may have seen posts about this on social media. The basis for these viral posts is true, though some of them may be slightly exaggerated. President Biden has expressed interest in changing the tax codes that impact inheritance, which includes property.
Here’s the tricky part — you can’t forecast tax code changes until they happen. For your financial advisor, this has been something of an issue over the last several years because tax codes are in danger of changing with the political party in power. The truth is that this doesn’t really impact the very wealthy in a detrimental way. They have access to great advisors and can develop strategic plans to shelter their inheritance in the best ways possible for heirs. Unfortunately, the people who are detrimentally affected by changes like this are the ones who can least afford the loss. This proposed tax code change would affect every person who has anything of value to leave as an inheritance.
We can’t say that the stepped-up basis tax rule will be eliminated. There are currently other things that will likely take priority for this administration. However, indications are that this change may be on the horizon within the first term. The best way forward for those who are inheriting a house is to stay informed on current and projected changes and be aware of your best financial strategy according to current tax laws.
Diane Kotkin a partner at the law firm Wright, Constable & Skeen, LLP in Maryland says “If President Biden is successful in eliminating the step-up in basis at the death of an individual, everyone should be concerned about what that will mean for their heirs and beneficiaries. A review of their estate planning documents will be necessary to assure taxes can be minimized as much as possible.”
What is estate tax?
An estate tax is a tax on the transfer of property after someone’s death. In 2020, the beneficiary is not required to file an estate tax return to the IRS unless the total value of the estate is $11.58 million or greater. Some states have their own estate or inheritance tax which may be at a much lower threshold. The estate tax itself is estimated by the total worth of the estate, prior to being split between any beneficiaries.
With the current tax codes as they are, you’ll be taxed on any profit made in the sale based on the estimated worth of the house when you inherit it. For instance, if you’re selling your mom’s house and it was worth $150,000 dollars when you inherited it, but you sell it at $170,000, you would need to pay capital gains taxes on the $20,000. This stepped-up exemption is currently applied to inherited properties. If, for instance, your mom bought the home for $50,000, and she sold it for $170,000, her capital gains tax would be on the $120,000 increase. You can see why the stepped-up basis tax rule is advantageous for those who want to leave assets to their beneficiaries.
Estate and Inheritance Laws in Some State
The IRS has its own rules and regulations about inheritance, but you also need to consider probate laws and inheritance taxes in your state. Each state has its own taxes and laws that govern inheritance (speak to your tax consultant for advise).
The estate tax might be an issue for you if you’re inheriting a house in Maryland because there are inheritance taxes in that state. The inheritance tax in Maryland can be as high as 10% for property passing to individuals who are not spouses or blood related to the deceased. If you’re inheriting a house in Virginia, there are probate taxes assessed on any inheritance over $15,000.00. If you’re inheriting a house in Washington DC the inheritance tax is on anything over $4 million dollars, which is lower than the Federal threshold.
Other Issues in Inheriting a House
Often the taxes you incur happen at the sale of a house. There are several family dynamics and issues that might go into your decision-making in regard to selling your dad’s house or managing any property you inherit.
Some questions you might have:
If I inherit a rental property is it taxable?
If the rental property was part of a larger estate, the estate would have to pay the taxes prior to changing ownership. However, there are some tax considerations you’ll need to know about with rental properties if you decide to maintain it. There are a few options. If you decide to sell the rental property, the same capital gains taxes would apply as those you’d pay in the sale of an inherited private home.
The rental property may already have tenants. In this case, you would need to consult the existing lease and decide if you’d like to keep the property to rent. Overall, your options are to sell, move into the property, or rent the property. Capital gains taxes at the time of sale would be assessed based on the market price at the time you took ownership versus the sale price.
When inheriting a house with a mortgage, how does that work?
There are several scenarios when you inherit a house with a mortgage. If there’s a larger estate or insurance policies, the deceased may have made arrangements for the estate to pay the remainder of the mortgage. If this is the case, the mortgage would be paid and you would own the home outright to sell or keep. In many situations today, older residents might have a reversed mortgage. This arrangement helps them maintain their bills until their death. The total due on this mortgage is never more than the worth of the home. The beneficiary would then sell the home, pay the balance on the reverse mortgage, and then keep the remainder as their inheritance.
If there is a mortgage and no plan in place to pay that mortgage, the beneficiary would take over the payments. There are laws in place to protect beneficiaries so that the mortgage company cannot demand payment in full on the existing loan. Most people cannot afford an extra mortgage, so the choice is likely to rent, sell, or live in the property.
If I’m inheriting a house with siblings, what are the options?
There may be stipulations in the will about which siblings own what percentage of a property. Often the property is split equally between all siblings. When you inherit a home jointly with siblings, it often becomes a personal choice on the best way forward. One sibling may want to live in the home. In that case, they would normally take out a mortgage to pay the other siblings their inheritance. You might decide to sell the property and split the inheritance that way. Some siblings will also decide to maintain the home as a rental property.
If I’m inheriting a house that needs work, what are my best choices?
Believe it or not, it’s fairly common to inherit a house that needs a great deal of work. Older family members often have outdated homes. This can range from very dated décor to serious issues, such as ancient mechanical equipment and a leaky roof. Your best choices when the home needs work really depend on your own ability to fix the damages and flip the home. Some people are very skilled with this type of work and take it on as a side project. This can mean turning a nice profit on the sale of the home. You might also decide you like the updated space so much you want to keep it.
If you’re not handy and the investment sounds like it might be too much, you can also sell the home as-is. There may be some cosmetic things you can do simply to bring the asking price up, but it may not be worth a major investment depending on the market.
Looking for Help With an Inherited Home?
If you’ve inherited a home or know that you will be inheriting a home in the near future, you may have some concerns. There are a lot of decisions to make in how to manage the property, whether to sell, and understanding the tax implications. Inheriting a home is also an exceptionally emotional experience. There are memories of the person who has passed wrapped up in the property. It may even be the home you grew up in.
All of these things can make the process confusing. That’s why it’s important to do some research so that you know your best interests are being met through the process.
My latest book, Tips, and Tricks for Selling Your Inherited Home is geared to walk you through the process. I’m currently giving this book away to help homeowners through this difficult time in their life. Stop by for your free copy.
Contact Marc Cormier for your FREE Copy at http://www.GuideToProbate.
Marc is a licensed Realtor with BHHS and can be reached at (301) 660-6272 x 700
Virginia Tax Code https://www.tax.virginia.