Most people become homeowners the old fashioned way -- they buy one. But many homeowners received their houses through inheritance, a process that brings with it good news (you were in the will) as well as issues purchasers don't face.

First of all, my advice to anyone who inherits a house -- seek legal and tax guidance from professionals before you do anything, sign anything, or promise anything.

Heirs have several choices regarding what to do with a residential property: move into it, rent it, or sell it. The choices seem simple enough, however choosing which route to tread is easiest with only one heir. If there are several heirs, they must first come up with ground rules to avoid animosity and frustration between the new co-owners/investors.

The ground rules may differ depending on the requirements of the estate and family dynamics. For instance, if the property is to be sold, several questions will likely arise.

  • Who will take care of getting the house ready for sale?
  • Who will handle negotiations with contractors?
  • How will the expenses of preparing the house for sale be divided?
  • Who will take care of the house while it's on the market or being rented out?
  • Who handles the hiring of the real estate agent?

If the house is to be rented, then heirs might ask:

  • Who will collect the rent?
  • Who takes the maintenance calls from tenants?
  • Where will the rental deposits and payments be held?
  • How will the income after costs be split among the heirs -- each month, quarterly or annually?

Sometimes, the heirs may decide to sell it to one of their own. Family members may want to "help" one of the heirs and pressure others into going along with reducing the house from its fair market value to a price the poorest heir can afford it -- or give them the property outright. These type of decisions can build animosity and strain otherwise good family relationships. They can also raise tax questions which should be explored before any arrangement is finalized.

If you're asking for my advice, and I know you aren't, if the will allows I would say sell the house outright and split the expenses, taxes and profits equally among the heirs. This way each heir walks away with their profit and does what they want to with it.

Regardless of which way you go, think about tax consequences.

The IRS has useful information regarding inherited property.

First, property received as an inheritance is not considered income (even if you receive the property as a gift). So a house worth $170,000 does not go down on your income tax form as an additional income. However, if the heirs decide to make the inherited home a rental property, income generated by the dwelling is taxable.

If the heirs decide to sell the property, they must adjust the basis according to the fair market value of the property the day the ancestor died.

Here's an example: If 30 years ago granddad bought the house for $45,000, owned it outright now, and then sold the house today for $175,000, his gain would have been $130,000 ($175,000 - $45,000 = $130,000). The heirs, however, get to now count the current fair market value the day granddad died. If the fair market value was $175,000 the day he died and the house sells for $175,000 -- then there is no gain.

(Nevertheless, granddad who sold it himself would get to take his exclusion of $250,000 at the time of the sale -- the heirs would not, since they had not lived in the house as a personal residence two of the last five years. So neither of the parties -- at least in this example -- would owe capital gains taxes.)

I haven't even gotten into what to do if one of the heirs moves in to the property and the others buy out their shares; or how to place the property into service as a rental and eventually sell it using the 1031 Exchange option to purchase another rental property, such as a beach house, ski lodge, or . . .

As you can see there are lots of options open to owners of an inherited property, but each comes with its own set of challenges. Get advice. Get plenty of professional advice.

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