When faced with an unexpected inheritance, the question of how to make the most of its value inevitably arises. Determining the best course of action can be a complex process—especially if the inherited home comes with looming financial obligations.
Before you decide to sell or turn an inherited home into an investment property, take time to weigh the advantages and disadvantages.
Start by consulting a real estate agent and property management service for their evaluation of the inherited home. This can help inform your decision of whether to turn the home into a rental property for passive income or renovate it to sell for a profit.
In complex circumstances where delays prevent a sale, such as when there are multiple heirs, real estate agents are an invaluable resource. They can also support by brokering the rental process, finding tenants, and coordinating viewings.
While an inherited rental property could be a lucrative asset, it won’t be without challenges. Take time to assess the risks involved and whether you can assume the debt and expenses if there are disruptions to rental income.
An inherited home presents several complex tax implications. As the new owner, you will be responsible for property taxes.
Additionally, while rental properties aren’t considered a source of earned income, the passive income they provide is still taxable, and you must report it. Thankfully, many expenses will be deductible.
The IRS allows for the deduction of expenses that are “ordinary and necessary for managing, conserving, and maintaining” a rental property. Eligible deductions include payments to a property management service, basic maintenance expenses, utilities, insurance, depreciation, property taxes, and mortgage interest.
These will apply if you decide to sell the home and make a profit. Whether that happens now or in the future, you will be paying capital gains tax whenever the gains are realized.
These taxes are levied at a very high threshold. As of 2023, when the assets of a deceased’s estate are valued below $12.9 million, they are excluded from federal estate tax.
These taxes are only levied in 17 states and Washington, D.C. While estate taxes are levied on the estate of the deceased, inheritance taxes are levied on the heir.
Residential rehabilitation loans support both the purchase and refinance for the renovation of residential real estate, making them ideal for neglected homes.
Rehab loans finance the cost of materials and labor for repairs, whether these repairs are needed to attract potential buyers or convert the home into a rental property. These loans can also save money by consolidating multiple renovation expenses into a comprehensive package or by refinancing an existing loan.
Residential rehab loans are available through the Federal Housing Administration (FHA) or private lenders. The FHA Limited 203(k) allows you to finance up to $35,000 into a mortgage for homes that need general, nonstructural repairs. The FHA Standard 203(k) can finance any amount of repairs as long as the total mortgage falls within the FHA’s regional lending limits.
Inexperienced investors may struggle to provide accurate repair estimates for a distressed property, which can delay or prevent government financing. Because private lenders aren’t restricted by the same regulations as the FHA, their qualification requirements will be more flexible. They will also be faster to close and able to provide larger amounts of funding for a wider variety of needs.
Evaluate multiple lenders, and be sure to ask questions about their requirements for rehab loans, payment penalties, and when to expect funding. Before making a financing decision, make sure you are well informed.
An inherited home can prove to be a wise investment, and Socotra Capital can provide the necessary financial support to purchase the property from other inheritors and even fund improvements. To learn more about how real estate investing can provide financial stability, read How to Grow a Passive Income Portfolio in Today’s Market.