We have talked about a lot of different topics over the last few months – everything from note sales, deeds, short sales and agreements for sale to what is title insurance and why do I need it? In brainstorming about this month’s topic, we asked IPX1031 Exchange for some tips. There are a lot of investors who are flipping properties as their strategy but there are also some who are buying for long term/estate planning. We thought this would be some great info for the long term investor!
What do three children do when they inherit one property? If you answered “Fight!” you would probably be correct. Frequently, people think 1031 exchanges are only useful to defer taxes when an investor wants to “reposition” assets. However, when a taxpayer dies, their estate receives a stepped up basis in the inherited property. As a result, all of the built in gain disappears upon the taxpayer’s death. For this reason, for estates not subject to the Federal estate tax (below the exemption level), a 1031 exchange is an ideal estate planning tool.
For example, let’s assume that Ted Taxpayer, a retiring baby boomer, owns a farm which is worth $900,000 and that has been fully depreciated. He has three children who live in different parts of the country and none of them are interested in continuing the family farm. If Ted sells the farm, he will pay taxes on $900,000; assuming a combined state and federal tax rate of 20%, he will pay $180,000 in taxes. This will significantly reduce the value of his estate and the only income that he will have is Social Security without reducing it further. For these reasons, a 1031 exchange provides an excellent opportunity.
Ted can sell the farm for $900,000 in a 1031 exchange and acquire three replacement properties, each worth $300,000. Presumably he would consult with each of his children in the selection of the respective properties and hire that child to manage a property creating an income stream for his retirement years. Each property could be placed into its own revocable living trust with one of the children being named as the beneficiary of the trust.
When Ted passes away, the properties will automatically transfer to the child who has been managing it, free of taxes and have a stepped up basis equal to the value of the property at the time of Ted’s death. If Ted were to die during the 1031 exchange, his heirs can complete the exchange and still receive a stepped up basis in the replacement properties.
Be certain to consult with your tax and legal advisors before entering into any plan relating to taxes and estate planning. If you are looking for more info on 1031 Exchanges, please feel free to contact us for a referral. Remember, Chicago Title is here to help with anything you need and are always just a phone call away!