Looking for creative ideas for 1031 exchange in real estate

[Huston55]

OP-

I had a related situation. After dealing with my CPA and making lots of inquiries on my own, I was fortunate enough to get the advice that I needed a sharp, aggressive tax lawyer; not a CPA. I have lawyer friends whose networking helped. It made a WORLD of difference for me; I’m in California.

I suggest you find a Nebraska tax lawyer as quickly as possible. You can start with the estate lawyer who did your Dad’s trust. S/he will likely not be the right person but, almost certainly knows local tax attorneys; these two specialties tend to run in the same circles. Good luck.

 

[OldShooter]

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.

Sorry if I came on too strong and I'm glad you are working on finding an expert for help. Sadly, you're right that it is not easy. But that doesn't mean its not important.

Re forum input, IMO it can be hard to separate the wheat from the chaff, particularly in technical areas like law and taxes. I have seen some pretty crazy stuff in areas where I do have some experience or expertise. If this is understood, a thread like this can be useful but IMO not actionable on its own.

 

[urn2bfree]

Invest in a QOZ fund. These are designed to defer capital gains taxes. By investing in real estate in Qualified Opportunity Zones you owe no taxes for now and the money grows tax free.

 

[all4j]

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

It does make a difference; however, I don't have direct experience. I hope once you get some answers you'll take the time to post back so we can learn.

There are a variety of trusts & each can have nuances that many think will not apply to them. Some will not qualify for a 1031, while others will. I would think typically a revocable living trust would pass through cap gains to the beneficiaries (& trust not pay the tax, but rather each beneficiary). It almost sounds as if there was a revocable trust, then upon death of the father the assets were poured into a irrevocable trust at a stepped up basis. And this irrevocable trust must pay ordinary tax rates (not cap gains rate) before distributing...

Also remember, as trustee, you are bound by terms of the trust. That may or may not maintain harmony between family members.

Good luck

 

[cathy63]

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.

Yes, you can do a 1031 with part of the property. It's a rare thing and you probably won't find experience here. Even if you did, it's irrelevant since every situation is different. You need to work with one of the firms that brokers 1031s for this type of property on a regular basis. Your estate attorney should be able to refer you to someone.

I think the 46% number from your CPA is probably wrong though. If this was a revocable living trust during your father's lifetime that later converted to an irrevocable trust upon his death, then the property got a stepped-up basis on the date of his death and you only owe tax on the increase in value since that date. So if it was worth $8M on that date and now it's worth $10M, you're only paying tax on the $2M, or when divided by 5 heirs on the $400K per heir.

Cap gains on inherited property are always treated as long-term gains. The max Federal LTCG rate is 20%. No state has a 26% tax rate, so I don't see how your CPA is getting to 46%. If he/she thinks the trust would be taxed as if this were short-term or ordinary income that would be 37% Fed tax plus state tax of 9%, so that could be where the number comes from, but I still don't see how income from the sale of inherited property can be taxed as other than a long term cap gain, especially since the trust has held it since 2020, so even if it were a less common type of trust it's still long-term.

Can you ask the CPA "Where does the 46% tax rate you quoted come from? Why doesn't the long-term capital gains tax rate of 20% + state tax for inherited property apply to this case?"

 

[all4j]

Yes, you can do a 1031 with part of the property. It's a rare thing and you probably won't find experience here. Even if you did, it's irrelevant since every situation is different. You need to work with one of the firms that brokers 1031s for this type of property on a regular basis. Your estate attorney should be able to refer you to someone.

I think the 46% number from your CPA is probably wrong though. If this was a revocable living trust during your father's lifetime that later converted to an irrevocable trust upon his death, then the property got a stepped-up basis on the date of his death and you only owe tax on the increase in value since that date. So if it was worth $8M on that date and now it's worth $10M, you're only paying tax on the $2M, or when divided by 5 heirs on the $400K per heir.

Cap gains on inherited property are always treated as long-term gains. The max Federal LTCG rate is 20%. No state has a 26% tax rate, so I don't see how your CPA is getting to 46%. If he/she thinks the trust would be taxed as if this were short-term or ordinary income that would be 37% Fed tax plus state tax of 9%, so that could be where the number comes from, but I still don't see how income from the sale of inherited property can be taxed as other than a long term cap gain, especially since the trust has held it since 2020, so even if it were a less common type of trust it's still long-term.

Can you ask the CPA "Where does the 46% tax rate you quoted come from? Why doesn't the long-term capital gains tax rate of 20% + state tax for inherited property apply to this case?"

Cathy, I respect your opinion in this type of situation & trying to learn a little something. At risk of diverting the thread, I'd appreciate you clarifying some.

1st, OP stated in an earlier post that there was a stepped up basis, but later land values skyrocketed. So, it sounds as if there are (potentially) substantial, as-yet-unrealized cap gains. I understand what you are saying about all inherited cap gains being long term & I agree something seems wrong based on info.

However, IF (big IF) property went up in value after being titled into a non-grantor accumulator trust, wouldn't the sale proceeds be considered ordinary income & not cap gains? If NIIT is added to top fed + state rate, it might get on up there...

Off hand I'm not thinking of a likely scenario where this would be the design of whoever setup the trusts. I think it most likely there is key info that isn't being factored in. I'd expect OP is just trying to carry out role of trustee & not educate me on particulars!

 

[Dot57]

Thank you all4j and Cathy63 for your detailed replies. My CPA told me the federal rate for the trust is 37% and the state and medicare tax is another 9%. I don’t know what the trust is classified as now, after my fathers death. How do I know if it’s considered a non-grantor accumulator trust? It was drafted in 1992 as a Revocable Living Trust.

 

[cathy63]

... However, IF (big IF) property went up in value after being titled into a non-grantor accumulator trust, wouldn't the sale proceeds be considered ordinary income & not cap gains? If NIIT is added to top fed + state rate, it might get on up there...

I am not an expert on trusts by any means (and without seeing the actual trust docs we're all just making guesses anyway), which is why I said to ask the CPA why the LTCG rate wouldn't apply in this case. If the CPA doesn't answer the question with something like "we have to consider this as ordinary income instead of long term cap gains because the tax code doesn't allow this type of trust to realize cap gains" or "the long term holding period for trusts is x years instead of 1 year" or some other understandable explanation, then I would suggest finding a new CPA.

The form 1041 instructions say "For tax year 2021, the 20% maximum capital gains rate applies to estates and trusts with income above $13,250". I assume the threshold will be higher for 2022 and 2023, but the max rate should still be 20%. I don't see anything in the instructions that says non-grantor trusts treat cap gains differently, but again, I don't know anything about the differences between a non-grantor trust and any other type of irrevocable trust.

edit: if this is treated as ordinary income, then NIIT should not be added. I believe that is only applicable to investment income.

 

[Huston55]

OP-

I had a related situation. After dealing with my CPA and making lots of inquiries on my own, I was fortunate enough to get the advice that I needed a sharp, aggressive tax lawyer; not a CPA. I have lawyer friends whose networking helped. It made a WORLD of difference for me; I’m in California.

I suggest you find a Nebraska tax lawyer as quickly as possible. You can start with the estate lawyer who did your Dad’s trust. S/he will likely not be the right person but, almost certainly knows local tax attorneys; these two specialties tend to run in the same circles. Good luck.

I see you’ve also consulted a tax attorney in addition to CPA. So, let me add to my previous post.

I was trying to avoid a six figure tax bill; not as large as your circumstance but, large for me. I was also using a CPA, a highly respected one. But, CPAs tend to be conservative on such matters, as mine was. This is because in cases like this, there is a fine line between accounting advice and the practice of law. Last thing a CPA wants is to cross that line; thus the conservatism.

So, I followed the advice of my estate lawyer friend, who said to use a tax lawyer instead. I followed this path for several months until being referred to a tax lawyer who was clearly the expert; we (my estate lawyer friend & I) knew immediately that she was the help we needed. She knew exactly what my goal was, told me it was achievable and how, cited the fact that she’s handled many such cases, then resolved mine. My advice, FWIW, is to keep searching until you get the right answer.

 

[ncbill]

Thank you all4j and Cathy63 for your detailed replies. My CPA told me the federal rate for the trust is 37% and the state and medicare tax is another 9%. I don’t know what the trust is classified as now, after my fathers death. How do I know if it’s considered a non-grantor accumulator trust? It was drafted in 1992 as a Revocable Living Trust.

I would expect as another poster noted the step-up on dad's death would be to something like $8 million if it's worth $10 million only two years later, so as they mentioned the $2 million LTCG would be split between beneficiaries, assuming an equal share.

Normally, with an irrevocable trust created on the death of your dad, any capital gains owed would be distributed to the beneficiaries for them to pay at their individual LTCG rate via the final tax return for the irrevocable trust.

I don't know if the above would require the sale of the farm, distribution of the proceeds to the beneficiaries, and filing the final irrevocable trust return all to happen in the same tax year.

So you really need to consult a tax lawyer or a CPA with a JD in tax law.