Five things you probably didn't know about inheriting a house

Inheriting a house may seem like winning the lottery, but you need to be prepared to make a number of tough financial and emotional decisions.

Here are five important things you probably didn't know about inheriting a home:

No. 1: Existing debt and bills will ultimately trump sentimentality

Even though you probably shouldn't make quick decisions in the wake of a loved one's passing, eventually you will have to decide what to do with an inherited home. You basically have three options:

1. Sell it
2. Move into it
3. Rent it out

If you are currently a renter, it might seem like a good idea to move in. But that can be complicated if you’ve inherited a family home with siblings or other relatives.

"If three of you inherit a house you're probably not going to live in it together," says Simon Brady, a Certified Financial Planner in New York City.

"That really leaves you with two options that generate money. One is simple: sell it and split it three ways. Or rent it out," he says.

Brady cautions inheritors to think twice before turning the home into a rental property, because becoming a landlord can be costly and time-consuming.

Besides, selling is often preferable if you -- or your siblings -- need the money right away.

"Debt collectors and bills will trump sentimentality in the end," adds Brady.

Of course, if you want the home and the other heirs do not, it might be possible to conduct a buyout of their interests in the inherited property. If you want to live in the property as your primary residence, a cash-out refinance of the property may be possible, provided you can qualify as a borrower and there’s enough equity in the home.

No. 2: You may get a huge tax break

If you sell the house, even if it appreciated significantly since the deceased person purchased it, you won't pay capital gains tax because the property's tax basis is "stepped to market value" at the date of death.

"The 'step' means that any increase in value over the cost of the home comes to you tax-free," says Rhea Friedman, a CFP in New York City. "You inherit it at the fair market value at the date of death."

"When you sell the inherited house, any tax you owe is based only on the increase in value while it is in your hands," adds Friedman, who also teaches tax planning at NYU's School of Professional Studies. For example, if you inherit a home worth $300,000 and sell it six months later for $315,000, the capital gains tax would apply only to $15,000 of the sale price.

No. 3: But you could get hit with other hefty taxes

Most people won't have to deal with federal estate taxes, which in 2022 is triggered when an estate has more than $12.06 million of assets.

While you may not owe the IRS, "The bar for state estate taxes be can much lower," says A. Timo Lipping, a CFP in New York City, who specializes in estate planning.

"Where the person you are inheriting from lived can make a big difference in how much you actually get to inherit," he explains.

For instance, taxes in Massachusetts and Oregon are levied on estates worth more than $1 million. Meanwhile, although New Jersey no longer taxes estates per se, residents are subject to an inheritance tax with a marginal rate up to 16 percent for certain inheritance recipients, Lipping adds.

No. 4: Even a "free" home can still be costly

If the house has an existing mortgage, the estate may settle it, if there are sufficient funds to do so. "You're usually getting a house free and clear of debt," says Lipping.

If the decedent's assets aren't sufficient to cover all outstanding debts and any mortgages or liens, the heirs will need to decide how best to proceed. This could be the case if the home had a reverse mortgage or home equity conversion mortgage on it; any outstanding amount would need to be repaid if you wish to retain the home. According to HUD, owners (or heirs) typically have six months to satisfy the debt. If the amount due on the HECM exceeds the value of the home, it may also possible to execute a "deed-in-lieu" transaction, where the title of the property is turned over to the lender.

Still, owning a home can be expensive -- even if you're not making mortgage payments. At a minimum, the property will still need to be maintained during the probate process.

"Property taxes, home owners insurance, liability insurance, heating, electricity, routine upkeep and general wear and tear can make a huge dent in your finances," cautions Brady.

"It's an enormous ongoing expense," he adds.

No. 5: You might inherit other "baggage"

Inheritances can be fraught with emotional consequences, as well as financial ones. You could find yourself dealing with not only a lot of physical stuff from a home inheritance -- like furniture, electronics, household goods or clothing -- but also other "baggage."

You and your siblings might want the same sentimental items like mom's favorite tablecloth, dad's class ring or your parents' wedding album. That can cause real strife within the family.

When prepping the home for new owners or new tenants, it can also be emotionally difficult to move certain personal belongings of a loved one who's passed away.

"Inheriting your parents' house almost certainly brings up all of the horrors associated with their deaths," says Friedman. "That is why many people cannot bring themselves to clear out and sell houses that they have inherited."

Many families find they cannot handle the stress that comes with cleaning out inherited property, so they do nothing for a year, which can be costly.

But Friedman warns against long-term inaction: "Not selling a house and not living in it makes for increased maintenance and insurance costs without much to show for them, and that financial stress adds to the emotional stresses involved."

Shop competitive mortgage lenders and see today’s mortgage rates

Keith Gumbinger revised this article.