Inherited property to rental?

Question

I have the opportunity to buy my siblings out of 2 inherited properties, one of which is my home growing up and the other has been a rental for over 50 years. Both are in a great location. How do I go about obtaining funds for this? The homeplace needs about $100K work done because it's never been updated and well.... was not well cared for the past 15 years due to my mother being ill.

I have 3 questions:

1) What is the downside of turning the homeplace to a rental and continuing with the other house as a rental?

2) I know I don't have to pay any tax on the inheritance but I'll be hit with cap gains when I go to sell, won't I? I can find a boatload of financial advisors none of which really know anything about investing in real estate. They all want to be liquid. I have always believed "everyone needs a place to live... not everyone 'needs' to own stock". Case in point, the market now.

3) How do I find financing to do this? There are other items inherited so we can haggle a bit but I need reno dollars and some to buy them out.

Nathan Gesner · Answer

Have you talked to a lender? You should have enough equity that you could take out a mortgage sufficient to pay the siblings off and you keep the property. You may even qualify to borrow enough to complete the renovations at the same time.

Talk to a lender to see what you qualify for, then crunch the numbers to see if it makes sense. If it doesn't cash flow, then you may be better off just selling the properties and walking away.

Ke Nan Wang · Answer

1. Downside would be the stress associated with the renovation and later property management. If you haven't done it before there will be a learning curve. Feel free to reach out to me if you like to go over more details.

2. You need to speak to a tax attorney/CPA/Enrolled Agent about this. Financial advisors are a different profession unless they are licensed and have been practice in tax laws.

3. Talk to lenders about financing the deal. Google them, ask around for referrals. Keep this in mind, one lender may not be able to help doesn't mean there is no help. There are so many lending products out there you just need to find the right one. Of course keep things in mind, higher risk (low/no equity, no collateral, low income etc) to the lender means higher interest rate. But don't let the absolute value of the interest rate deter you from getting a good deal. For example, if you talk to one lender who's willing to help you finance the deal for 10% rate, don't let the 10% scare you. Crunch the number and see what's your net and if the number makes sense. Often high interest breaks the deal but it's not the law. And you always have the option to refinance it to a lower interest rate with a different mortgage product later down the road (keep in mind the closing cost associate with the refinancing has to also make sense).

Joyce C. · Answer

I'm rather well versed in renovations. Went through it with the house I'm living in. I'm a Project Manager full time so I know how to create and stick to schedules and coordinate between contractors. Thing is there are a lot of contractors that are price gouging in my area. Roofs are anywhere between $8K - $15K. Crazy! Some things like painting and tilework I can do myself but I can't upgrade electricity or plumbing. Considering hiring a home inspector to get a good idea what needs to be repaired or upgraded first.

I've considered a 203K renovation loan also. Can borrow up to 110% of the future value after renovations. But then there is the Fannie Mae HomeStyle mortgage that is less cost associated with it. The lending is where I'm stuck. If I buy 2/3 of $500K, my LTV is still 67% and the PITI payment is more than the rent. Seems like I should consider a 10/1 ARM. I know I will be selling it within 10 years. Too many unknowns at this time until I get the inspector and contractors to give me prices.

I'm considering putting both houses in an LLC but not sure the benefits to me as a single person. Guess tax attorney/CPA could best answer that? Before I buy them out I want to have all these questions answered so I know what I'm getting into completely.

Brad S. · Answer

Hopefully, this isn't in CA, since the property tax laws just changed on inherited properties. If it is in CA, the tax basis will adjust to today, unless you live in the "homeplace". That would be a negative, if it is in CA. But, in other states you shouldn't have that concern.

Once you have the "homeplace" as a rental, you can later sell and 1031 exchange into something else, or get a DSCR loan. You may also be able to get a DSCR loan now, on the current rental. Maybe there would be enough money there to do what you want. Good luck!

Joyce C. · Answer

Virginia. Believe the tax basis is from when mother passed, 2015.  I am very well versed in 1031 exchanges and have been certified in them! Had a rental myself years ago wanted to do a 1031 but some other person got in the way and it didn't work out that way.  What is a DSCR Loan? I'm really hoping to get both properties because of the development to happen in the near future.

Peter Mckernan · Answer

@Joyce C. I just had a client in the same situation with one property, he ended up refinancing the property (property was free and clear), paid off his brother 50% of the property value and now the client is renting it out. If there is debt, you can refi the property pay the sibling what is there and then agree that you will pay them the rest in 1yr or when you get that money. If the sibling does not like that you can refi it pay them some of the cash they are owned then give them a small percentage of the cashflow. Or you could sell one pay off the sibling with those funds and then pay off the debt that is on the other one if there is debt.

Joyce C. · Answer

UPDATE:  Given the rate hikes some of the property values have declined as have the monthly rental rates. Still have not settled on the inherited properties because the market is all over the map and, quite frankly, dealing with siblings who have no knowledge of the RE market is not fun.

First thing I did was have a home inspection. You know... I don't want to insult anyone .... really! However, I think that industry is bunk. I made sure I hired someone that was "certified" to at least 'feel' they would provide more insight than just my views. The report I got back only had check marks that he 'inspected' the area. No commentaries except that the roof "MAY need to be replaced". A blind man could see the roof needs to be replaced! Has needed ti for 7 years!!! My expectation was that I would get a report that said "yes... I inspected that area and found.... nothing/repairs listed/needs update to code/ or something more than a simple checkmark. Please correct me if my expectations are off mark!

Main concern comes with number crunching... Income/Expense/ROI. Given the rent has gone down in these 2 markets, the value has maintained BUT the cost to bring the home property up to date is still high due to inflated construction materials. Need new roof, 2 baths and the kitchen at a bare minimum updated and here that is going to cost $95K. (I really REALLY wish I could do at least some of it myself but I just can't. Well, the tile work and painting but that's like spitting in the ocean trying to create a title wave.) Now... that, in and of itself, is not 'terrible' but add to the financing to buy siblings out, and the lower rent, I'm not even going to break even BUT have a loss! So the ROI doesn't seem to be there on the inherited properties. One would think its a cake-walk. Additionally, have not been able to locate someone to discuss the taxes on inheriting the properties. Don't even know what those may be or when they need to be paid.

Had considered 203K financing but I think that has its own pitfalls because, my understanding, have to use THEIR contractors. How do I know 'their contractors' are going to do the best/proper work and not cut corners?? Govt run policy/process does not necessarily mean it's good.

Plan is to have at least one of these properties to provide additional income during retirement but it doesn't look like I can make that happen unless I flip the house and reinvest the proceeds. THEN taxes will be paid on the net UNLESS.... maybe... 1031 exchange! Maybe get both houses, sell the one that's ready for rent and put THOSE proceeds into the other house.

Your thoughts are more than welcome!!

Albert Bui · Answer

HI Joyce,1) I dont see any downside of converting into a rental you can create some cashflows out of inherited assets2) not a CPA however you inherited them so they come to you a stepped up cost basis based on the date you received these properties so you should technically have any gain unless they've gone up since you took legal possession of them and even then its probably margin increase in equity if your award was recent.3) Financing these properties will be easier if you have long term leases otherwise lenders will just look at these as liabilities this is why you may want to get in place long term leases first. The other option is if your personal earned income is high enough where you can qualify for conventional loans on these properties with even having tenants, this would be a nice situation to have but tougher.Hope that helps, let me know if you have any questions.

@Matthew Kwan@Carlos Valencia

Basit Siddiqi · Answer

Inherited properties normally have a step-up in basis.Talk to a CPA how this impacts your basis which is then used for items such as depreciation or gain calculation upon sale.

Richard Bechtol · Answer

The tax basis for capital gains would be the date of passing of the last owner. You should have an appraisal done but let the appraiser know the date of value and why you need that date of value. The further you get away from the date the more difficult it will be to have that appraisal done. Just keep the appraisal as a record if and when you do sell the properties yourself.

Inherited property to rental?

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