What to Do With Grandma’s House: Inherited Properties, Step-Up Basis, and Rental Income
If you’ve just inherited the primary residence of a grandparent who has passed away, you probably have a lot of questions about the real estate market and capital gains tax.
iNTRODUCTION
If you’ve just inherited the primary residence of a grandparent who has passed away, you probably have a lot of questions about the real estate market and capital gains tax. Does the home need to go into the probate process or will there be a smooth transition? What are the tax implications and what kind of capital gains tax are you looking at? Should you sell the home for fair market value or try to leverage it as a rental property for passive income?
In this blog, we’ll discuss the tax benefits and disadvantages to keeping an inherited property, and how you can leverage the property to help pay for property taxes or improve your current financial situation.
The Emotional & Financial Crossroads of Inheriting a Home
It goes without saying, but inheriting a primary residence from somebody who has passed away comes with an incredible emotional toll. You might want to keep the home and use it as a vacation home to maintain your family legacy, but the property’s condition or the opinions of other heirs has you second guessing yourself. Selling the home right away may not always be the smartest move, but keeping a home means paying for a second set of utility bills and mortgage payments.
There are a lot of factors to weigh before a new property owner can make an informed decision about whether or not to sell the property, and we’re here to clear up some common questions about capital gains tax and the financial implications of keeping an inherited property.
Understanding the Step-Up Cost Basis
When you inherit a property, the tax value of the property (or its “basis”) is updated to its current market value at the time the owner dies. For example, if your grandparent bought the house for $100,000 in 1988 but it’s worth $600,000 at the time of their passing, your new tax basis is $600,000. If you sell for $620,000, you’ll only pay tax on the $20,000 “gain”, not the $520,000 difference. This is sometimes referred to as an inheritance tax.
So, why does this matter? Well, depending on your specific situation (where the property is located, if there are tenants, your current financial goals, debts, and outlook), it might make more financial sense to hold onto the property for a little while before selling and dealing with realtor commissions.
Why Not Sell the Investment Property Right Away?
If you’re thinking about hanging onto the property and consider it a valuable asset, you’re not alone. There are many reasons why you’d want to hold onto an inherited property and use it as a rental property, including:
- Emotional reasons. As discussed, losing someone important to you carries a huge emotional toll. You might want to keep the inherited property for a little while longer so you can grieve your grandparent, even if it means paying mortgage interest or a higher inheritance tax. It's important to not make any major financial decisions in a time of grief, so give yourself some time to grieve before you decide to sell the property. There may also be other beneficiaries involved who you'll need to discuss the matter with.
- Financial reasons. Selling immediately may not maximize the value of the inherited property. The real estate market constantly fluctuates. Meet with a real estate agent, property management company, or financial planner to discuss your specific situation. They'll be able to look at the fair market value of your inherited property and put together forecasting to determine if now really is the right time to sell.
- Tax implications and planning. In addition to the above personal representatives, you should also discuss the real estate property and its potential rental income with a trusted CPA. Waiting to sell the property may allow for better timing around capital gains tax and estate considerations. They understand your specific situation, the inheritance tax implications of keeping the property, and how it fits in to your financial goals and your property taxes as a whole.
Renting Out an Inherited Home for Airbnb: A Smart Interim Solution
If you’d like to hold onto the home in the short-term until you can consult with a financial planner and accountant, renting out the inherited property on Airbnb or another short-term rental platform could make a lot of sense. You’ll be able to create passive income while holding onto the asset as it grows and the property will be kept in the family for longer. Putting the home on Airbnb means you’ll benefit from appreciation while taxes remain favorable under the step-up basis.
For many, the day-to-day management of the property is the most difficult part. This is where a professional co-host and/or property management steps in.
How a Co-Host Can Help With Property Management
When it comes to managing the complex and time-consuming parts of your rental property, there are several ways an experienced and professional co-host can help, including:
- Listing management- A co-host can help you get grandma's house ready for Airbnb (or to be used a long-term rental) without the emotional stress. They can create and optimize the listing to get more traffic (which equals more money for you!), and can even stage and take high-quality photos for the listing. They'll think of all the little touches that make your listing more guest-friendly.
- Guest communication- Communicating with guests isn't a 9-5 job; it's a 24 hour a day, 7 days a week kind of thing. From booking requests and inquiries to guest issues and concerns, a co-host will handle all guest communication from the beginning to the end of their stay.
- Cleaning and maintenance- Everyone has heard horror stories about major messes left behind by guests that require deep cleaning or minor renovations. Our cleaning checklist and maintenance team ensures your investment property will be kept in good condition for its eventual sale. We'll communicate anything major to you right away.
- Revenue management- Meehan Property Management uses dynamic pricing to make sure your investment property will earn as much as possible. But, at the same time, we are careful with our vetting process so that the competitive prices don't attract the wrong kind of guest.
- Compliance guidance- Finally, we'll make sure your listing is compliant with local laws and regulations surrounding short term rentals. This is especially important in California where short-term rental rules vary by city.
Key Takeaway – Don’t Rush, Plan Smart
As you can see, inheriting a home is both a blessing and a new responsibility. Selling isn’t the only option and, thanks to the step-up basis, holding and renting the home may be more profitable in the long-term. If you have questions about how to turn an inherited property into a source of rental income while you plan your long-term strategy, reach out today to learn how we can help.
FAQs Section
Here are some common questions we receive about capital gains tax and the rental income potential of an inherited property.
What is the step-up basis in inheritance?
A step-up in basis is a tax provision that adjusts the cost basis of inherited assets to their fair market value at the time of the original owner’s death, rather than the original purchase price. This can significantly reduce or eliminate capital gains taxes for the heir, as it means the appreciation of the asset during the deceased’s lifetime is not taxed.
Is it better to sell or rent out an inherited home?
Neither selling nor renting an inherited property is inherently better; the right choice depends on your personal circumstances, other financial goals, and willingness to manage the property. Selling the property provides immediate cash, which can be used for other investments or debt, and avoids the time commitment of being a landlord. Renting can provide a steady, long-term income stream and potential for property appreciation, but it requires time, money for upkeep and renovations, and the responsibilities of being a landlord.
What if I live out of state and inherited a California property?
Living out of state does not prevent you from inheriting a California property, but you should be prepared for potential complications like the need for an “ancillary probate” if the deceased had no will, and consider tax implications, particularly the impact of California’s Proposition 19 on property taxes if you decide to rent out the property. A qualified California real estate attorney who is well versed with the real estate market in the state and a financial planner is recommended to help you navigate the process.
Can an inherited home with an existing mortgage be used as an Airbnb?
Yes, you can use an inherited property with an existing mortgage as an Airbnb, but you must first verify that the mortgage terms and local regulations permit short-term rentals.