There are concrete steps you can take to minimize the pain of hidden costs when you’ve inherited property so you can actually enjoy your inheritance.
Whether you’re inheriting a childhood home, vacation beach house or rental property portfolio, you’ll inherit more than childhood memories or a beloved family getaway spot. You’ll also have expenses that may be both unexpected and greater than expected.
But that doesn’t mean you can’t minimize the costs of inheritance. Here’s how to tackle these five hidden costs of inheriting real estate.
1. Estate Taxes
Federal estate tax applies when an estate’s value, including real estate, exceeds a certain threshold ($5.49 million in 2017 for an individual’s estate or $11 million for married couples, provided the surviving spouse files a portability election to lay claim to the unused exclusion amount).
True to its name, the estate tax comes out of the estate before you take ownership of inherited real estate. That means your property should only be affected if the estate lacks sufficient liquid assets to pay estate taxes. 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.
Selling your inherited property may subject you to capital gains taxation. However, if it’s an investment property, an allowance called a 1031 like-kind exchange gives you the option of selling it and reinvesting the proceeds in a similar property without incurring capital gains tax.
2. Appraisals
An inheritance of real estate 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 in Atlanta.
Most often, you’ll want a step-up in basis valuation so that the cost basis of the asset is “stepped up” to its fair market value at the time of the owner’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 your return. A landlord’s required insurance policy can cost as much as 25 percent more than a homeowner’s 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 deciding what to do with inherited real estate. You may be surprised how much it costs to heat a Vermont ski chalet or the century-old family mansion.
Your analysis may reveal 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, on average you’ll pay approximately 0.546 percent of the assessed value of the property in property taxes, while in Biloxi, Mississippi’s Harrison County—merely 60 miles west of Mobile—you’ll find an average tax rate of 0.7 percent. And head about 60 miles east of Mobile to Pensacola, Florida’s Escambia County, you’ll find a property tax rate of 0.806 percent. 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.
No matter what you decide to do with inherited real estate, Koepp says it’s important to have a strategy in place before you inherit the property to understand the costs involved and how to minimize them.
While this could be a difficult conversation, ultimately the benefactor hopes the inherited real estate brings you happiness, not headaches—and talking about possible problems beforehand can give you and your benefactor peace of mind. Whatever course of action you take, decisions should not be made lightly. Your Regions Wealth Advisor may be able to help weigh your options and identify your goals for the inheritance.
