You've Inherited Property,
Most people think that inheriting property is an easy process, providing the beneficiary a lottery-like reward with little to no detriment. The truth is being named as a beneficiary is not that simple and while the reward is obvious, there are also many challenges that a beneficiary of inherited real property faces. Unless you're the surviving spouse of inherited property, in which case, the legal transfer of the property should occur relatively quickly and without tax penalties, receiving an inheritance in almost any other circumstance can be a long and complicated process, that can take the executor of the estate and the court many months, or more, to divide the deceased person's assets, including the home. Often times, this is a very aggravating and stressful process for beneficiaries, who are not only dealing with the loss of a loved one, but also may be struggling financially and need the money to stay afloat.
Follow the will
The first step in the process is to determine whether the deceased person has a valid will. If the deceased person has a valid will and the estate is worth more than $100,000., the court will follow the terms of the deceased person's will and through the probate process, make sure the deceased person's debts are paid and assets are distributed accordingly. If the deceased person does not have a valid will, his or her assets will be distributed according to the state laws of intestacy, which are default provisions that are commonly contrary to the deceased person's wishes.
Creating a will is a smart decision; however, many people will be surprised to learn that simply having a will cannot avoid a court process called "probate" and sometimes, to the bewilderment of all involved, the desired beneficiaries of the deceased person are not the people who actually inherit the property. Not only will some of the beneficiaries of the deceased person not receive their inheritance, but going through probate takes the control of inheritance from the family that is very expensive, time consuming, and "public," so any interested party can see what the deceased person owned and who the deceased person owed money to.
Once ownership of a home is transferred to you, Uncle Sam may deduct federal, state and/or local taxes from the estate, if the estate net taxable is worth more than a certain amount.
There is no inheritance tax in California. Estate tax is under the federal estate tax law. Estate taxes are taxes that are levied on an entire estate before it is distributed to individuals, which is imposed on the value of the property at death. The federal government tax rates start at 45% for estates in excess of $3,500,000. If you were to inherit property worth $4 million, for example, the federal estate tax would be $225,000.
Consider selling the property
If you decide to sell an inherited home, you will probably be required to pay capital-gains tax on the difference between what you net from the sale and your basis (basis equals purchase price plus improvements minus depreciation). One positive thing about inherited property is that it is taxed on the value of the property the day that the owner died. Therefore, the beneficiary gets a "step-up" in basis and pays less capital-gains tax. The current federal capital-gains tax is 15%. If the property is a personal residence and you meet certain guidelines, you can be exempt from capital-gains tax on the first $250,000. if single, or $500,000. if married.
Example: Let's say John Doe buys his home for $10,000.00 in 1945. Sally Q inherits John Doe's property on the day John Doe dies in 2010. At the time of John Doe's death, the property is worth $350,000. Sally Q would pay no capital gains tax if she sells the property for $350,000. a week after John Doe dies as the basis of the property (value upon John Doe's death) is equal to the value of the property upon Sally Q selling the property.
Unless you qualify for an exception under the law, most transfers of property call for a reassessment of the property, which will likely increase the property taxes paid on the property. Therefore, as a practical consideration, a beneficiary of inherited real property must make sure that they will be able to pay the increased property taxes as they become due, or ultimately risk the chance of losing the property in the future for delinquent property tax payments.
Understand the downsides of inheriting property
While inheriting real property can seem like a blessing, many find that they have to sell the inherited real property to pay the estate taxes due. In addition to the large amount of estate taxes that may become due after inheriting a property, there is a quick nine month statutory period after the deceased person's death in which the beneficiary of inherited property must pay the estate taxes due.
Example: If a beneficiary inherits one parcel of land worth $10 million and the estate has no other assets, the beneficiary of the inherited property may have to sell the land to get the cash to pay the $2.9 million in federal estate taxes within nine months of the deceased person's death.
Taxes are not the only complications a beneficiary of inherited real property encounters. The bottom line is that if the home still has a mortgage attached to it, it will have to be paid off. Worse yet, some lenders treat the death of a borrower as a trigger for immediate repayment of the loan. However, if the loan provisions provide for survivorship of the loan through a trust or deed, the loan will remain outstanding and in effect.
Thus, a beneficiary must be careful and make sure they can pay the estate taxes and annual property tax payments, as well as the monthly mortgage payments.
Step 1 - Appraisal: The first step for a beneficiary of inherited real property is to have the property appraised to determine the fair market value at the time of death. This establishes the new tax basis in the event that the property is sold, so the tax implications of selling the property can be assessed and evaluated to determine if selling the property is the best course of action.
Step 2 - Determine Price/Terms: Once you decide to sell the home, you will need to determine a price and terms to sell it. To help you with the price, terms, and overall transaction, you will need to enlist the services of qualified professionals.
Step 3 - Hire Professionals: At the very least, you should hire a real-estate broker as well as various consultants, including an appraiser, surveyor, real estate lawyer, and accountant.
Special Note: Regardless of whether the beneficiary decides to sell the home or not, the beneficiary must get property insurance while he or she is the owner to avoid potential liability or loss via fire.
One of the biggest issues any person who inherits property will have to deal with is clearing the property title, which can be a very time consuming and cumbersome process. The transfer of real property is exceedingly hard when more than one beneficiary is named. Unless the will is very clear about the percentage of ownership each beneficiary receives, or includes provisions about what will happen if one beneficiary wants to sell the home while the others do not, be ready for costly disputes to arise.
Clearing title is especially daunting when there are multiple family related beneficiaries (as is often the case) as familial ties can become strained when the intent of the deceased person is unclear and the beneficiaries have differing ideas of the wishes of the deceased person.
What one does with the inherited property obviously varies from person to person. Some people keep the real property for various reasons ranging from sentimental (inherited home is childhood residence) to financial (inherited property in a depressed market and want to wait until the home rises in value). Others may desire an income stream and thus, they sell the property and buy another one with the income. For people who desire to sell the property and acquire another "like kind" property, a tax deferred "1031" real estate exchange can be a very beneficial tool to avoid property tax.
Disclosure: The numbers in this document may not reflect the most recent data.