3. Do your children get along?
The median US home price – half lower, half higher – is $319,200. If you have multiple heirs and leave them a house worth hundreds of thousands of dollars, it can be difficult for them to agree on what to do with it.
“If children are geographically distant from home, which is more common today, this can cause dissension among recipients – particularly if all the maintenance is being done – as they may not be taking full advantage and enjoy the intended home as an inheritance,” says Gregory Giardino, CFP in Hawthorne, NJ
4. What is the title of the house?
The rules vary by state, but for many married couples, a home is typically owned in joint ownership with right of survivorship (sometimes called tenancy by entirety), which means that if one spouse dies, the other has complete ownership of the house. If both spouses die at the same time, ownership of the home is decided by stipulations in their will (or, in the absence of a will, by state probate laws).
It will also be important for the heirs to determine the title of the house and the operation of the property. What if one heir wants the money, and the other two want the house? In this case, the heirs who want the house will have to buy out the one who doesn’t, either in cash or through an intra-family financing agreement. The last resort, of course, would be the court system, which is generally not the best place to form family ties.
Finally, are there any liens on the home for debts owed, such as tax arrears or defaulted loans, that would come due when the ownership of the property changes? “Kids are often surprised to learn this,” says Patricia Hausknost, CFP in Long Beach, Calif. “If they exceed the value of the house, it’s best to tell the first lien holder of the death and walk away.”
5. What is the tax situation?
Uncle Sam wants a cut when a house is sold for a profit. The amount of a discount depends on what is called the cost basis of ownership. Simply put, you are taxed on the difference between what you paid for the house and what you sold it for. But it is not that simple. For tax purposes, you can also add the value of certain expenses, such as major renovations, to the purchase price of the home to increase your cost base and thus reduce the amount of profit on which you would have to pay taxes. Confused? The IRS has a lot more on the basis of costing.
Heirs get a break based on costs. Under current law, when someone inherits a house, they get what’s called a phased base, which means their cost base for taxes is as of the date their parents or estate settlement. In other words, if they sell the house, the heirs won’t have to base their capital gains tax on what their parents paid for the house. Suppose the parents bought the house for $50,000 in 1980 and the house was worth $319,200 on the day the estate was settled. The heirs would have no profit on the house if they sold it immediately, and therefore no capital gains tax to pay.
Parents could also sell their home today and, under the current tax code, have $250,000 of the profit excluded from capital gains for each person — meaning a $500,000 exclusion from capital gains for a married couple. Some parents are tempted to transfer title to the home to their children while the parents are still alive. “Do not do that !” said Hausknost. The heirs will be responsible for household expenses, including liability, and they will not get the base increase.
It should also be noted that one of the features of President Joe Biden’s current tax reform proposal is the elimination of the progressive base. “From a financial perspective, without the increase rule, it would make little difference whether the original owner left the house to the heirs or sold it himself,” says David Silversmith, CFP in Plainview, New York. “But under current law, I would advise my clients to keep the house and leave it to their heirs.”