Does an Heir Inherit Equity or Market Value?

By John Cromwell

An heir is someone who inherits property from an estate. The traditional definition of an heir is someone who inherited property, due to being related to the decedent, when the decedent left no will. The modern definition of an heir encompasses everyone who receives property from an estate, whether through intestacy or as a beneficiary in a will. Regardless of which definition is used, whether a person receives the equity or market value of estate property depends on the probate process and the terms of the will.

Equity Versus Market Value

Equity is the value of a property minus the amount of the person owes on the loan against it. The market value is how much a person would get if she sold the asset on the open market. This assumes that the “seller” is not under any pressure to sell the item and that the “buyer” does not have any pressure to obtain the asset. For example, assume someone bought a house for $400,000 subject to $200,000 mortgage but could sell it for $500,000. The equity value of the house is $300,000, but the market value is $500,000.

Probate Process

Probate is a state regulated judicial process meant to facilitate the distribution of a decedent’s assets to the proper recipients. When a decedent dies, the court will review any available will, certify it and appoint the executor named in the will to oversee the estate. If there is no valid will, the court will generally appoint a family member of the decedent to oversee the estate. The executor will gather all of the decedent’s probate assets and generally pay off the decedent’s debts. Once the debts are paid, the executor will distribute what remains, based on the decedent’s will or if there is no will, based on the state’s intestacy code.

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Heir's Portion

Generally the heir will receive the market value of any property he receives from the estate, because during the probate process, the executor will pay off all outstanding claims, assuming any assets remained in the estate after all debts were settled. This would include mortgages and other liabilities attached to property. However, because mortgages have some tax benefits, it might not be in the best interest of the eventual recipient of a mortgaged property to have the debt paid off. If the will gives the executor the discretion to not pay off a mortgage on a property and the lender agrees, the recipient might only receive equity as opposed to market value.

Tax Basis

While a person is not taxed on the property she receives from an estate, she may be taxed on the proceeds she receives when she sells the asset in the future. "Basis" is the value of a taxpayer's investment in property and is used to calculate gain or loss on the sale of an asset. The basis of property received by a person from an estate is measured at its market value as of the day the decedent died. So if a house was worth $200,000 when the decedent purchased it five years before but is worth $300,000 on his date of death, the heir's tax basis is $300,000. The basis generally remains constant, unless the beneficiary makes additional investments and improvements to the property.

Selling Inherited Property

When the inherited asset is sold, you would subtract its tax basis from the proceeds from the sale to determine the taxable gain or loss. Assume a beneficiary had a basis in a house of $200,000 and later sold it for $300,000. She would have a taxable gain of $100,000. However, in the rare situation where the heir took over he mortgage on the inherited property, any outstanding loan amounts due would be subtracted from the proceeds of the sale.

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How Can the Executor of an Estate of a Life Tenant Allocate the Appreciation to the Beneficiaries?
 

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