12/16/08: Dealing with Inherited Property
By Benny L. Kass
Q: My father passed away in January, 2008 and I have inherited his townhouse. He had an existing mortgage. I am continuing to make the mortgage payments. I have not notified the mortgage company. I am unable to obtain financing for a home in my name at this time, and have been turned down twice by mortgage lenders. Does Maryland law allow me to assume this loan? If the lender finds out, can they pull the loan? I don't want to lose the house. There was a will (I was the PR and sole beneficiary) and I had an attorney prepare the deed which was already recorded in my name. If I sell the home and pay off the finance company, are there capital gains taxes or other taxes that I may have to pay? It was my father's wish that the house be mine upon his death, yet I am afraid if I notify the mortgage company, I could lose the home. I am considering selling, but don't know how much would have to go to taxes.
A: Please relax. You are absolutely safe. So long as you continue to pay the monthly mortgage, you can stay in the house and fulfill your father's wishes.
There is a higher law than Maryland. There is a Congressional mandate that protects you. In l982, Congress enacted into law the Garn St. Germain Depository Institutions Act of 1982, which among many other matters, specially addressed your issue. According to that Act, a lender "may not exercise its option pursuant to a due on sale clause upon .... a transfer to a relative resulting from the death of a borrower".
I am sure that the mortgage documents which your father initially signed contained what is known as a "due on sale" clause. This means that should the property that secures the mortgage be sold or transferred to a third party, the lender has the absolute right to declare the entire loan due.
The purpose of such a due on sale clause makes sense. If a lender makes a loan with a low interest rate - say 5.5 percent - and interest rates rise significantly, the lender does not want another person to step into the shoes of the original borrower and continue making payments at the original low rate.
But Congress recognized that the due-on-sale clause was unfair to many people, especially in situations such as yours where you inherited the property - and the existing loan.
You should send your lender a copy of your father's death certificate, and merely advise that you will be taking over the mortgage payments. There is absolutely nothing that the lender can do to hurt you.
Your attorney did the correct thing by recording a deed into your name. Too many people in your situation just ignore the process, only to learn later that the house is still in the name of the deceased person. In order to sell the property at a later date, a probate estate has to be opened in the jurisdiction where the deceased was domiciled.
You also asked about the tax consequences should you ever decide to sell the house. Since you inherited the house, you are entitled to what is known as the "stepped-up" basis. This means that your basis for tax purposes is the value of the property on the date your father died. Make sure that you have this number; you should be able to find it among the probate papers - or the final tax return - that your probate lawyer filed with the Court. If not, then I suggest you hire a professional appraiser to give you this value as soon as possible. The longer you wait, the harder it will be to determine the date of death valuation.
Let me give you an example. On the date of death, the house was appraised at $400,000. This is your tax basis. If you sell the house for that amount, you will not have to pay any capital gains tax. You may have inheritance and estate taxes to pay but your attorney will explain that to you.
If you have not owned and lived in the property for at least two years, you will have to pay a capital gains tax on any profit that you may make. If, for example, you are able to sell the house for $450,000, ignoring for this discussion any closing costs or real estate commissions that you may pay, you will have made $50,000 ($450,000 - $400,000). At the current 15 percent capital gains tax rate, you will have to send the IRS a check in the amount of $7500. You will also have to pay some Maryland tax on your profit.
However, once you have owned and lived in the house for at least two years, you are eligible for the up-to-$250,000 exclusion of gain (or up to $500,000 if you are married and file a joint income tax return).
It does not appear that you can qualify to buy another house, so why not stay where you are. You should also talk with your current lender to see if you can at least qualify for a refinance loan. Interest rates are very low now, and it never hurts to ask.