Another 1031 Question

chisueMay 15, 2009

I am trustee of an irrevocable trust. It holds a rental property purchased using 100% of the sale of a previous property. It was a 1031 transfer.

The basis value of the first property is 8% of the current value of the 'new' property. (I'm using raw numbers, not deducting sales costs, atty fees, depreciations, etc.)

The property can be appointed to our DS or DGS (or anyone I choose), or they will inherit it within the trust.

How does the IRS look at this situation? Does the property change in status? Will DS owe capital gains on 92% of the sale if title changes to his name -- even if he doesn't sell it? Can he continue to sell and buy using 1031 protection?

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brickeyee

You have a couple of considerations in transferring the property.

The person receiving the gift assumes your (low) cost basis.

You will also very likely have gift tax issues since you can only give $10,000 per year per person to a single person without gift taxes occurring (a couple can give $10,000 each).

If you bequeath the property, at death the estate will pay any taxes due (but no federal taxes are normally due unless the estate is $1 million plus) and the recipient of property gets a stepped up basis to market value on the date of death (or other valuation date selected by the estate).

    Bookmark   May 16, 2009 at 8:42AM
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brickeyee

If grandson is under 18 they can accept title, but cannot transfer title.

Putting real property in minors names is a real hassle since a court appointed guardian must sign for the child to convey title or encumber the property.

    Bookmark   May 16, 2009 at 8:44AM
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chisue

brickeyee -- Thanks for the clear reply. It sounds as though the best option is for the trust to continue to hold the 1031 property (and any subsequent exchanges) and let DS inherit.

The trust is over $1 million. Will this invite a closer look at the 1031 portion? When you say the estate will pay taxes due, are capital gains on this property part of what's due? (Because the title changes?)

I'm happy to think that the 1031 property can go on and on, with DS holding or buying and selling but never paying capital gains on that miniscule basis, but...isn't that too good to be true?

    Bookmark   May 16, 2009 at 10:38AM
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kellywa

Regarding the gift tax I believe for 2009 it will be $13,000 per person or $26,000 for husband and wife. I know last year's was $12k.

Even though tax rates are currently low (some would argue that I am sure) they will probably never be this low again. Something to keep in mind.

    Bookmark   May 16, 2009 at 1:51PM
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brickeyee

"The trust is over $1 million. Will this invite a closer look at the 1031 portion? When you say the estate will pay taxes due, are capital gains on this property part of what's due? (Because the title changes?)"

Estate taxes are not the same as capitol gains.
They are a separate part of the IRS code.
I have not had to deal with estate taxes in about 5 years, and there have been some changes.
The estate will pay taxes on the fair market value of the assets.
The 'no tax' value for 2009 is up to $3.5 million.

"I'm happy to think that the 1031 property can go on and on, with DS holding or buying and selling but never paying capital gains on that miniscule basis, but...isn't that too good to be true?"

The estate will pay taxes on the assets and the cost basis carried forward will be the fair market value that the estate tax was based on.

You should talk with an attorney experienced with estates and trusts.
There are a lot of pitfalls and planning can reduce (or even eliminate) some of the taxes along the way.

Here is a link that might be useful: IRS Estate tax info

    Bookmark   May 17, 2009 at 9:35AM
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chisue

brickeyee -- Thank you. The trust won't exceed the $3.5 million unless we have a sudden economic shift -- a hugely inflationary one!

I know I need to consult our accountant and/or attorney, but thanks for fielding my question. I know trusts can subject to different laws than individuals, too. It's probably 'way too complicated for the forum!

    Bookmark   May 17, 2009 at 3:32PM
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brickeyee

Trusts also need to follow any applicable state laws.

The only state I have been involved with trusts is Virginia.

Just remember that a revocable living trust is a way to speed up transfer of property on death (the property is not part of probate) but has no federal tax advantages.

There are other types of trusts that do have tax advantages.

    Bookmark   May 17, 2009 at 5:53PM
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chisue

brickeyee -- This trust is irrevocable. I am sole trustee. Once DS reaches age 45 (and after my death) he is sole trustee. The trustee has power to appoint, to buy and sell, etc.

My question just concerns how the 1031 property within the trust will be treated 1) upon my death, and 2) upon DS's death. It seems as though the trust can continue to own the property without paying capital gains at least through DS's lifetime. (Whether that's adviseable or not is another question, but isn't the mantra to postpone paying taxes as long as possible? -- Inflation gambit?)

DH and I each have revocable living trusts.

    Bookmark   May 18, 2009 at 11:39AM
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brickeyee

It depends on how title is held even within the trust.
When the first person dies a portion of the property is considered as part of their estate.
That portion gets a 'stepped up' cost basis.
When the second person dies the property is part of their estate, and gets another bump in cost basis.

Taxes are only due from the estate on the estate's value.

Property in the trust is still part of the estate, title passes without probate.

    Bookmark   May 19, 2009 at 9:49AM
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chisue

brickeyee -- You'll be thrilled to know I faxed some questions today to an attorney familiar with the irrevocable trust that holds the 1031 property.

I *think* you are referring to a revocable trust, not irrevocable. The trust holding the 1031 property became irrevocable when the settlor died. Estate taxes were paid then. The basis for the property was established then. That was 30 years ago, which is part of the reason the basis is so low.

    Bookmark   May 20, 2009 at 12:26PM
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