The Brilliance of 1031 in Estate Planning

We often talk about the immediate benefits of a 1031 Tax Deferred Exchange. 1031 is a great way to preserve equity, reposition assets and defer substantial amounts in taxes.  What many do not realize is that 1031 Exchanges are a great estate planning tool.

Think about this. If you sold an investment property outright, between federal and state capital gains tax, depreciation recapture, and the possible 3.8% net investment income tax due, you may pay approximately 25-40% of your profits to the government that tax year.  That payout would result in you having just the remaining funds left over to deposit into your savings account to be eventually passed on to your heirs.  

Alternatively, with your sale structured as a 1031 Exchange, you would sell the property and use all of your profits to purchase new investment property.  By using all proceeds to purchase replacement property of at least equal value to the property you sold, you defer 100% of the capital gains tax and other taxes otherwise due.  That means you keep all of your equity working for you. And in fact the income generated would most likely be higher than any savings account earnings.

1031 BENEFIT: Heirs Receiving Stepped-Up Basis

If you are holding investment property that had been part of a 1031 Exchange, upon your death, your heirs get the Stepped-Up Basis.  All of the built in gain disappears upon the taxpayer’s death.   What that means is the value of the property at the date of your death would pass through your estate to your heirs.   If they decide to sell the property for that same appraised value, there would be NO capital gains tax due to be paid by your heir, as opposed to the 25% to 40% cash you would have had to otherwise pay the government if you sold outright, rather than exchanging.  What better way to help the future of your heirs?

Here’s an example:  You own an apartment building for many years. You are making estate plans and strategizing how to leave this one property to your three children in your estate. Rather than hold the one building you know your children do not want to own or manage, you decide to sell it for $1,800,000 as part of a 1031 Exchange.  

Presumably you would consult with each of your children in the selection and acquire three separate replacement properties, each worth $600,000, to benefit from the 100% tax deferral. 

Working with your legal counsel, 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 you pass away, the properties will automatically transfer to the named beneficiary, free of taxes and with a stepped up basis equal to the value of the property at the time of death.

1031 BENEFIT: Pulling Out Equity Later  

By participating in a 1031 Exchange, you could have continued income from the new rental property. And you have the option later on to potentially pull equity out if you need funds for something else, such as supplemental living, improvements to be made or even paying for college tuition.

Here’s an example:  You bought a rental property a few years back for $400,000 and now you are able to sell the property for $600,000. That is a potential gain of 200,000. That amount, minus any improvements made and closing costs, would be taxable at the capital gains rates.   Paying $50-$80K in taxes now just to put the remaining funds in a low interest savings account may not be the best use of your equity. 

1031 BENEFIT: Converting Rental to Personal Use Property

On the residential side, buying a Replacement Property in an area you plan to retire to allows you comfort of knowing the local market you are renting in now, continued income while owning the investment, and the option in a few years for you to convert the property use from investment to personal.  At that time it could become a second home for you, family and friends to visit or even your primary residence in retirement.   

Be certain to consult with your tax and legal advisors before entering into any plan relating to taxes and estate planning.  

Read More

How to Buy Your Vacation Home with a 1031 Exchange
Strategically Buying Your Dream Vacation Home with a 1031 Exchange
Do Vacation and Second Homes Qualify?
Revenue Procedure 2008-16


IPX1031 – Choose the Experts

IPX1031 focuses solely on 1031 Tax Deferred Like Kind Exchanges. With over 30 years as the national leader of exchange services, IPX1031 expertise, strength and security are unmatched.  We pride ourselves on keeping our clients and their advisors current on tax issues pertaining to section 1031 Exchanges and applications. We aim to be your complete informational resource and to provide you with the knowledge, support, documentation and protection necessary to guide you through the Exchange process.   For further guidance on how to fully maximize this powerful strategy, please contact IPX1031. 

How Important is Your Qualified Intermediary?
Safety and Security for Investors
Disaster Relief Extensions
1031 Exchange and Defer? Or Sell and Pay Taxes?
Capital Gains Estimator
IPX1031 Knowledge Center


Pin It on Pinterest