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. 


The Potential of an Inherited Rental Property

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.


Opportunities as a Rental 

  • Entry into Real Estate Investing: If you haven’t been in a position to own due to high real estate prices and high-interest rates, the windfall of an inherited home can be an advantageous way to add to your investment portfolio. 
  • Consistent Income: Rental payments arrive on a reliable schedule. 
  • Sentimental Value: As a rental property, the home will allow you to keep a connection with the family member that left it in your care. 
  • Debt Coverage: If the inherited property comes with a mortgage you can’t otherwise afford, you could use rental revenue to cover the debt. 
  • Passive Wealth: Over time, rental income can become much more substantial than a cash sale of the home. 
  • Short-Term Rental: If the home is in a desirable area, listing it as a short-term vacation rental can maximize the revenue opportunity. 


Challenges as a Rental

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.

  • Renovations: If the home is in disrepair when you inherit it, updating it to be ready to rent will require time and money.
  • Depreciation: Tenants may not care for a home the same way an owner might. This accelerates the rate of repair, impacts the property's value, and requires more frequent maintenance than a private home. 
  • Potential Losses: If tenants miss payments or the home sits unoccupied, this can cause financial strain. And, if a tenant misses their payments, this can lead to the difficult pressure of having to confront them.
  • Proximity: For out-of-state heirs, proximity to the home will add significant weight to the pros and cons of selling inherited property. It will impact appraisals, inspections, repairs, and renovations.
  • Legal and Zoning Requirements: Housing and tenant laws are not universal. Additionally, some cities have restricted the use of residential homes as rental properties, particularly as short-term rentals. 


Learn how to build a successful real estate portfolio in the current market.


Tax Considerations for Real Estate Investments

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. 


Tax Deductions 

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. 


Capital Gains Taxes 

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. 


Estate Taxes 

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


State Estate and Inheritance Taxes 

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. 


Financing Renovations for an Inherited Rental Property

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. 


A Promising Financial Future

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


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