Looking for creative ideas for 1031 exchange in real estate

[Dot57]

I am the trustee for my fathers estate. He passed away in 2020 at nearly 100
years old. We children (5) will inherit more money than we ever dreamt because the family farm is in an area where commercial property is in high demand. We
recently received an unsolicited offer of $10 million. We now are each trying to determine the most tax efficient way to handle the inheritance. Wondering if anyone here has experience with 1031 exchanges and have suggestions on what they have done to pass on inheritance money to avoid such a big capital gain?

 

[Montecfo]

So you got a basis stepup in 2020 and have substantial appreciation since?

 

[pb4uski]

You should get a stepped up basis for the property for it's value as of your dad's date of death so your capital gains would only be the excess of the $10 million over the stepped up basis.

You'll likely want to get one or more professional appraisals of the value when you dad died to document the stepped up basis.

 

[Dot57]

Yes, this was land my father inherited in the 70s. We had an appraisal done after his death so it stepped up the value to $56k per acre. The offer is now $145k per acre so there will be significant capital gains. I’m trying to think outside the box of how I might do an exchange that my kids could inherit one day to minimize paying so much tax.

 

[Stormy Kromer]

I would not try to do this all by myself. You're looking at big dollars here and need some experienced advice. And not from someone who can profit from putting you in a 1031 exchange.

I know 1031 offers some tax advantages, but you may end up buying back some land that has appreciated just as rapidly over the past two years, or worse, buying some land that hasn't, meaning it isn't going to in the future either. Real estate is a hands on investment and you really need to know the value (and potential future value) of what you're buying. Would you be better off with the new parcel than you are with the one you own now ? I wouldn't do it just for tax purposes.

Get some professional help and consider paying the favorable capital gains tax rate for the two years of appreciated gain and invest it however you'd like and not back into real estate.

Just some thoughts. Good luck. Keep us posted.

 

[pb4uski]

Yes, this was land my father inherited in the 70s. We had an appraisal done after his death so it stepped up the value to $56k per acre. The offer is now $145k per acre so there will be significant capital gains. I’m trying to think outside the box of how I might do an exchange that my kids could inherit one day to minimize paying so much tax.

+1 Consult a tax pro, but I think tha the capital gains tax should be $13.3k per acre (15% of the gain) so you'll net $131.7k per acre. If it were me, I would take it and be thankful rather than trying to monkey around with a 1031 exchange.

If the buyer is creditworthy, you might consider an installment sale to spread the capital gains over several years, especially if the additional income is bumping you into another IRMAA tier.... OTOH, sometimes it is best to just rip the band-aid off in one fell swoop.

 

[Montecfo]

It suggests to me the appraisal may have been too low. That is a huge difference. Did you have more than one done?

I wonder if there is any way to revisit it.

 

[ncbill]

Yes, this was land my father inherited in the 70s. We had an appraisal done after his death so it stepped up the value to $56k per acre. The offer is now $145k per acre so there will be significant capital gains. I’m trying to think outside the box of how I might do an exchange that my kids could inherit one day to minimize paying so much tax.

Or you get another appraisal that takes a more careful look at comps back in 2020 & the new one values the land back in 2020 at much closer to $145k/acre.

 

[Dot57]

We have been keeping an eye on all of the land sold in the area the past few years and the appraised value seems in line with most of the other sales.

Thanks for all of your input.

 

[all4j]

I am the trustee for my fathers estate.

A few points of clarification. Not to pick on words, but are you 'trustee' of a trust or executor of an estate? Some trust will not get a basis step-up.

Was the appraisal done for 'current' use or 'highest-and-best' use? These are different & if appraised as current (farm), but being sold as commercial....

Is property currently owned by the estate? Are you looking at dealing with the land in its entirety or dividing between the 5 & then doing a 1031 with just your 20%? Also, I think 1031 has to be 'investment' property & I'm not clear if this qualifies. But there will be lots of bumps in road for a 1031.

 

[Stormy Kromer]

What concerns me the most about a 1031 is that the quality of the real estate that you're purchasing in exchange. If I have a pile of money that I NEED to invest in real estate in a short period of time, am I going to have a decent selection that I can purchase.

Or another way to put it Would I buy this piece of real estate if I didn't have to ?

I own a lot of real estate but it is all farmland that I have acquired over the years. I bought it right and was very selective. I doubt I could have done the same if I was forced to buy real estate in a certain time frame.

 

[captain3d]

The 1031 exchange only has to beat a guaranteed tax loss.

 

[ERD50]

What concerns me the most about a 1031 is that the quality of the real estate that you're purchasing in exchange. If I have a pile of money that I NEED to invest in real estate in a short period of time, am I going to have a decent selection that I can purchase.

Or another way to put it Would I buy this piece of real estate if I didn't have to ?

I own a lot of real estate but it is all farmland that I have acquired over the years. I bought it right and was very selective. I doubt I could have done the same if I was forced to buy real estate in a certain time frame.

+1 You go from owning this land, to owning some other land. Why not just hang on to the land if you hope to pass it to heirs at stepped up basis (which could possibly, maybe, go away in future tax revisions)?

The 1031 exchange only has to beat a guaranteed tax loss.

But their tax hit is less than 10% of the offer price (assuming 15% cap gains on ~ 60% of the sale price being gains). A lot can go wrong that could be greater than 10%.

-ERD50

 

[money4wells]

I agree with most of the comments. If you do check out 1031 Exchanges, I have found these to be good places:

www.1031crowdfunding.com - Good for research or a free consult on all the basics.

Crowdstreet - For finding investments in short time frame. You can do DST's and there is a regular schedule of ones available every month. You could diversify with them, spreading out your investments over several properties in different areas. You have to be an accredited investor though.

 

[luckydude]

I echo other posters in advising caution on doing a 1031 exchange just to avoid paying cap gains tax.

Here's a useful link on the 1031 exchange: https://www.investopedia.com/financial-edge/0110/10-things-to-know-about-1031-exchanges.aspx

You can exchange into different kinds of investment real estate, not just land. The real question you need to ask yourself is whether you have any real estate investment experience and what is your investment goal. Do you have the expertise and experience to identify another good property, do all the due diligence and risk assessment, and close on that property within 180 days as prescribed by the 1031 exchange rules? How will you manage the new property? And what is your investment goal with the new property (e.g. income, long term capital appreciation, etc.)?

If you don't have any experience with real estate investment, you should just pay the cap gains tax and take the proceeds. Don't let the tail wag the dog by rushing into another real estate investment that you don't have experience in or don't know how to manage, because in the long term, buying the wrong property will likely cost you more than the tax you save with the 1031 exchange.

 

[Dot57]

Thanks to all of you who replied. I appreciate all of the input.

 

[all4j]

The main thing that is clear is that we don't have enough info to offer specific suggestions; understand why OP may decline to further elaborate. Circumstances are a bit unusual: estate seems open ~2 years and counting, we don't know other assets (such as cash) & how 'farm' keeps going (assuming still farming?). Even original per acre amount is way rich for farmland & to more than double in 2 years says there are unique circumstances. Joint ownership of real estate is difficult & 1031 doesn't change that.

To other posters: multiple have cited cap gains tax at 15%....how is 20% avoided?

To OP: I appreciate wanting to be tax efficient but would suggest reframing your thinking some. An inheritance of this size may call for a change in how you think from previously. Land has appreciated more since death than the tax rate, so after paying the tax, you still have more than originally. Depending upon your state, you may have owed more in estate tax if it had originally been valued at $10m.

Dealing with it while in the estate means 1 decision maker -- the executor. Once distributed to heirs there are 5 with equal say. These situations can often tear apart families with competing interests -- one wants cash, another wants higher price, another wants to keep, etc. There are factors other than financial to consider

 

[Dot57]

After meeting with an experienced tax attorney on this subject I've learned there are many complications as you've noted. This farm has been in our family for generations and the area is being engulfed by large company data centers. The market values are sky high because of this.

 

[Stormy Kromer]

After meeting with an experienced tax attorney on this subject I've learned there are many complications as you've noted. This farm has been in our family for generations and the area is being engulfed by large company data centers. The market values are sky high because of this.

That is good fortune for you. I would highly recommend getting an experienced commercial realtor to represent you in determining the market value and to represent you in your negotiations. Commercial buyers are much more astute on real estate transactions than the average seller.

It sounds like the sales proceeds are going to be legacy money for your family. Think about what would would be a good long term investment and easy to distribute to your heirs when the time comes.

Good post to discuss. Best wishes to you and condolences on your loss. I know how farmland ties famiies together (and can also divide them). Sounds like now is a good time to transition for your family.

 

[Dot57]

Trust taxable rate is 46% - Yikes!

I learned from my CPA today that the taxable gain needs to be paid by the trust at a rate of 46%. This makes the 1031 exchange even more desirable. Does anyone have experience doing a 1031 exchange when a trust is involved? With 5 siblings as beneficiaries, I'm sure at lease 2 or more won't want to hassle with the 1031. Wondering if we can do a partial exchange when a trust is the owner of the land.

 

[ncbill]

I learned from my CPA today that the taxable gain needs to be paid by the trust at a rate of 46%. This makes the 1031 exchange even more desirable. Does anyone have experience doing a 1031 exchange when a trust is involved? With 5 siblings as beneficiaries, I'm sure at lease 2 or more won't want to hassle with the 1031. Wondering if we can do a partial exchange when a trust is the owner of the land.

So an irrevocable trust?

A run of the mill revocable living trust would use your dad's lifetime exemption.

 

[Dot57]

It is a revocable living trust. Does that make a difference?

 

[OldShooter]

@Dot57, WADR consulting SGOTI is not what you should be doing here. For one thing, you are letting the tax tail wag the investment dog. There is much more to strategy here than just looking at a 1031 exchange.

Suppose you hire an expert (which you absolutely should) and the expert costs you $10,000 but helps you develop an optimum strategy. That $10,000 is a tenth of one percent of what you are trying to optimize here. Negligible in context.

You already have a CPA. If he/she is not a expert in large transactions like this (which is probably the case), ask for a couple of referrals Same-o your attorney; ask for referrals. Interview several candidates and check references. Finding highly capable advisors is where you ought to be focusing your efforts, not on cooking up your own amateur strategy in consultation with SGOTI.

 

[Letj]

46% seems somewhat odd. Why would the gain on sale be so high? Taxes on gain from real estate is either 15% or 20% (doesn’t matter if it’s held in a trust)

 

[Dot57]

OldShooter, I absolutely would love to hire an expert and am more than willing to pay for the service. This is easier said than done. It is like trying to find a good therapist. You have to go through lots and lots of interviews before you finally find one that has the skillset you need. I am in the process of doing this and thought there may be some good input on this forum as well. Maybe I'm mistaken...isn't that what the forum is for? Sharing life's experiences.