Who Pays the Mortgage on Inherited Real Estate?

Real estate agent showing house information to a special needs couple, sitting in the kitchen table.
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Whenever there is a death in a family, stress levels rise. In addition to the emotional toll, the financial realities of dealing with an estate after a death can sometimes be even more overwhelming. This can be especially true in the case of inherited real estate.

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Many heirs are unaware of exactly how real estate passes from a decedent’s estate, particularly if there’s still a mortgage attached. If you anticipate inheriting real estate at some point in your life, it pays to learn about the process ahead of time so that you’re prepared to handle it. Here are the most important things you’ll need to know.

Who Pays the Mortgage on Inherited Real Estate?

In most cases, whoever inherits the real estate is responsible for paying the mortgage on it. After someone dies, the heirs will have to contact the lender to document what happened, which usually involves filing some paperwork and submitting a death certificate. At that point, the mortgage will typically be transferred into the names of the new owners of the home, who will be responsible to continue payments. Note that heirs can continue to make payments on the mortgage even before the paperwork has been processed and the account has been formally transferred into their names.

There is one case in which the new owners of a property may not be technically liable for paying the mortgage, and that is if there was a co-signer on the original mortgage. Co-signers are legally responsible for the entire mortgage upon the death of another co-signer, regardless of whether or not they are beneficiaries of the actual property. 

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What Is a “Due-on-Sale” Clause?

A “due-on-sale” clause typically allows a lender to immediately require a mortgage debt be paid in full upon the transfer of ownership. For example, if you sell your home, your mortgage company will require that you pay off the balance of your loan in full. This is usually accomplished by deducting the debt from the sales proceeds. But in the case of inherited real estate, this clause is typically waived, based on federal law. This means that heirs can avoid having to pay off an inherited mortgage in full.

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Does the Process Differ if the House Is Held in a Trust?

If advance preparations aren’t made, a home will pass to heirs through probate. Probate is a public, legal process in which the disposition of a house follows state laws and is accessible to anyone who cares to look. This process can take time and may not always follow the wishes of the decedent.

If a home is placed in a trust, on the other hand, the whole transfer process is much cleaner, faster and less public. A home can pass privately through a trust directly to specified heirs, avoiding the slow public process that can also sometimes lead to surprising or unplanned results. 

Can I Sell the House To Pay the Mortgage?

An important thing to note is that if you don’t want the legal responsibility of paying off a mortgage on a home you don’t want, you can always sell it. In fact, rather than being saddled with yet another monthly expense in the form of a home mortgage – and related property taxes, maintenance costs, possible HOA fees, and other expenses – many heirs simply choose to use the house itself to pay off the mortgage. Selling a house also carries the benefit of turning an illiquid inheritance into liquid cash, which is both easy to distribute and often preferable for heirs to have. 

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Will I Owe Capital Gains Taxes?

One of the true gifts in the U.S. Tax Code is that inherited real estate enjoys a “step-up” in basis that all but eliminates capital gains taxes on heirs who sell property. A step-up in basis simply means that for tax purposes, the purchase price of a house “steps up” from the original cost to the actual market value at the time of the holder’s death. Since capital gains taxes are based on the difference between the cost of an asset and its selling price, this essentially eliminates capital gains taxes on homes that are sold immediately after death. 

If you buy a stock at $10 per share, for example, and sell it at $25, you’ll owe capital gains taxes on that $15 gain. But if someone buys a home for $100,000, dies when the house is valued at $250,000 and the heirs immediately sell it, they won’t owe any capital gains taxes. For tax purposes, the home will show as being “bought” at $250,000 and sold at $250,000, resulting in no taxable gain.

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