An inherited house isn't such a wonderful bequest if taxes eat up your gains when you sell it. Your gains are measured as the difference between the property value on the day the owner died and the price you get when you sell. Say your parents buy a house for $120,000 and die when it's worth $200,000. If you inherit, your gain is measured against the second figure.
The "step up" in value from the purchase price to the death-date value goes a long way to cutting your taxes. No matter how much the house has appreciated while your parents owned it, none of that counts as gain. If you put the house on the market as soon as your name is on the deed, it may not have time to rise in value before you sell. If the house is worth $200,000 and you sell it for that, there's no tax, even though you've just made a $200,000 windfall.
When figuring you gain, take into account any money you spend to make the sale. If you take out a classified ad to announce the home's on the market, that's a deductible expense. So are any commissions you pay to a real estate agent. If you sell the house for $220,000, say, and pay a 2.5 percent commission, that's $5,500 off the total gain. If the house was valued at $200,000 when you inherited it, your gain drops from $20,000 to $14,500.
If you're looking for another investment, you can swap the rental for another property in a 1031 or "like-kind" exchange. To do a 1031 exchange, you sell the rental home, leave the money with a middleman, and then buy another investment property within six months. You can choose a commercial site or even raw land, rather than investing in another residential rental property. If you swap a $200,000 house for a $205,000 rental duplex, say, you have only $5,000 in gain.
Suppose the market's flat when you inherit, but you expect it to pick up in two or three years. If you don't want to sell immediately, moving into the house is one way to cut your gain when you finally do sell. If you own and live in a house for at least two of the five years before you sell, you get to exclude $250,000 of the gain on the house from taxes. If you're filing a joint return, you may qualify for a $500,000 exclusion.
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