By: Randall A. Denha, J.D., LL.M.*
With every windfall comes great obligations, so be prepared for the surprises you may encounter when inheriting property. Inheriting real estate from your parents is either a blessing or a burden — or a little bit of both. Figuring out what to do with the property can be overwhelming, so it is good to carefully think through all of your choices.
There are three main options when you inherit real estate: move in, sell, or rent. Which one you choose will depend on your current living situation, whether or not you have siblings, your finances, whether the house has a mortgage or liens, and the physical condition of the house. The following are some things to consider:
Taxes. In most situations, you do not have to pay taxes on property you inherit, but if you sell the property, you will be subject to capital gains tax. The good news is that inherited property receives a step-up in basis. This means that if you inherit a house that was purchased years ago for $150,000 and it is now worth $350,000, you will receive a step up from the original cost basis from $150,000 to $350,000. You should get an appraisal done as soon as possible to find out how much the house is currently worth. If you sell the property right away, you should not owe any capital gains taxes. If you hold on to the property and sell it for $400,000 in a few years, you will owe capital gains on $50,000 (the difference between the sale value and the stepped-up basis). On the other hand, if you use the property as your primary residence for at least two years and then sell the property, you may be able to exclude up to $250,000 ($500,000 for a couple) of capital gains from your taxes.
Mortgage. Does the house have a mortgage on it – either a regular mortgage or a reverse mortgage? Sometimes it is specified in the estate plan that the estate will pay off the mortgage. In cases where it doesn’t, with a regular mortgage you will likely have to assume the monthly payments. There are some mortgages, however, that require the heirs to pay off the mortgage immediately. With a reverse mortgage, you usually have a limited time to pay off the mortgage in full. Typically, upon the transfer of ownership to real estate which is encumbered with a mortgage, there is a due-on-sale clause contained within the contractual documents that created the mortgage and note wherein the entirety of the mortgaged monies will become accelerated on transfer and become immediately due and owing to the lender (i.e., the entire loan is billed rather than just the installment payment). Nonetheless, recipients of real estate incident to the death of the owner needn’t concern themselves with such a clause because Federal Law preempts (i.e., overrides) the lender’s contractual right to call a mortgage where either the recipient of the property is a relative of the decedent-borrower or where the recipient was a joint tenant on the deed of the property with the decedent-borrower prior to death.
Repairs. It is a good idea to hire a home inspector to assess the condition of the house. If the property needs significant repairs, it may affect what you do with it. Renovations and repairs can be costly and time-consuming. You may want to consult with a realtor before taking on any big projects. It may not make sense to spend a lot of money on the house.
Property Maintenance. Once you inherit the property, you will be responsible for maintaining it. The first thing you want to do if you inherit property is make sure the utilities and homeowners’ insurance are transferred to the new owners and continue to be paid on time. You will also need to pay all the property taxes and any other fees associated with the property.
Insurance. You cannot keep the decedent’s prior homeowner’s insurance policy following the death of the decedent-insured when you inherit any real estate. While there is a Federal Law that enables certain recipients of real estate to keep the decedent’s mortgage intact, there is no such law with respect to the decedent’s homeowner’s insurance. Nonetheless, the standard homeowners insurance policy does extend insurance benefits initially and upon death of the decedent-insured to the legal representative (i.e., executor or administrator) of such insured during the interim period existing post-death and pre-distribution to the ultimate beneficiary (i.e., while an executor or administrator is probating / administering the Estate). Yet, this extension of limited coverage may be curtailed by other policy exclusions, such as the loss of coverage if the property is vacant for 60 consecutive days before an occurrence of a peril or some other period set forth within the policy. Make sure to read the homeowners policy, which had named the decedent as the insured, to know the rules of the policy and don’t assume anything.
Rental. Where real estate is encumbered by a home loan, not a reverse mortgage, you may be able to rent your inherited real estate without first refinancing the mortgage from a residential home loan to an investment loan. Relevant to the due-on-sale clause discussed herein with respect to mortgage transfers, the recipient of real property who qualifies for due-on-sale preemption can also rent the property for up to 3 years, during any rental term, without the monies in the mortgage becoming due and owing to the lender through a separate exception to the due-on-sale clause pursuant Federal Law. Without this Federal Law preemption, a person with a residential mortgage for their primary residence would be precluded from renting the property without first refinancing to an investment loan. So, those inheriting real estate can utilize the real property inherited as an income stream instead of immediately liquidating through sale or choosing to occupy the premises themselves. Nonetheless, before you rent out your inherited real estate, make sure to comply with local law from where the real estate is located with respect to obtaining any requisite rental permits and through avoiding illegal transient (i.e., short-term) rentals or be prepared to face citations with fines and possible jail time.
Other Owners. If you inherited the property with siblings, you will all need to agree on what to do with the property. If one sibling wants the property, he or she can buy it from the other siblings. Otherwise, you can sell or rent the property and split the profits. If there is a dispute among siblings, you can try professional mediation. In mediation, the disputing parties engage the services of a neutral third party to help them hammer out a legally binding agreement that all concerned can live with. The disputing parties can control the process and they have a chance to explain their perspectives and feelings. If you go to court, the judge will likely order the house to be sold so the profits can be split.
Ultimately, there are many decisions to make when you inherit real estate and deciding what to do with it can be a very emotional decision. If possible, try not to rush into any decisions until you’ve had time to thoroughly consider your options.
*Randall A. Denha, J.D., LL.M.., principal and founder of the law firm of Denha & Associates, PLLC with offices in Birmingham, MI and West Bloomfield, MI. Mr. Denha continues to be recognized as a “Super Lawyer” by Michigan Super Lawyers in the areas of Trusts and Estates Law; a “Top Lawyer” by D Business Magazine in the areas of Estate Planning and Tax Law; a Five Star Wealth Planning Professional; Michigan Best Lawyers; Michigan Lawyer of Distinction and a New York Times Top Attorney in Michigan. Mr. Denha can be reached at 248-265-4100 or by email at firstname.lastname@example.org