If you’ve completed a 1031 exchange before, you likely know how important it is to plan for potential issues. These transactions can be extremely valuable tools, but faulty like-kind transactions can cause a tremendous headache and result in large tax bills. Doing a little prep work can save you a considerable amount of time and money.
One particularly unpleasant potential issue to be aware of is the possibility of a death occurring during (or after) a 1031 like-kind exchange. This isn’t pleasant to consider, but to be fully prepared, you should at least be familiar with the rules pertaining to this issue.
The rules that apply if a death happens during a like-kind exchange are favorable to taxpayers and their relatives. The tax code has been wisely devised so that the deceased taxpayer’s surviving family members are placed in a financially beneficial position. Here’s a look at the specifics of this issue in the example below.
Death During a 1031 Exchange: Can a Transaction Continue?
The most important point to mention is that a 1031 exchange can be completed if an exchanger dies in the middle of a transaction. Suppose a taxpayer who initiates a standard 1031 exchange passes away after his or her relinquished property is sold, but before the replacement property is acquired. This unfortunate occurrence does not necessarily result in a failed transaction.
In such a scenario, the estate of the taxpayer can complete the transaction by following all of the rules and filing all of the necessary paperwork. The transaction would be viewed by the IRS just the same as if it were completed by the actual taxpayer and a successful transaction would, therefore, result in a deferred capital gain.
Inherited Property and Stepped-Up Tax Basis
Another significant point you should consider is what happens when a replacement property is inherited after the death of a taxpayer. If a replacement property is inherited by a person from the estate of a taxpayer who completed a 1031 exchange?or whose estate completed the exchange?then this replacement property will have a stepped-up basis that is equal to the property’s fair market value when the inheritance occurred. In practice, this means that whatever gain was deferred in the original like-kind exchange transaction will be eliminated entirely following the inheritance. This is because the basis will be increased such that the previously deferred gain can never be recognized.
Given this reality, we can see that 1031 exchanges can be useful estate planning tools. No matter what a taxpayer’s basis may be at the time of his or her death, the heir who inherits the property receives a stepped-up basis, which essentially eliminates the gain. So section 1031 can remove extremely large tax liabilities by simply redirecting property following the original owner’s death.
In fact, many taxpayers use section 1031 for precisely this purpose. Because of this stepped-up basis principle, they deliberately use section 1031 in estate planning to bequeath property free of preexisting capital gain.
Planning for a death during a 1031 exchange is unpleasant to think about but necessary to be fully prepared. Luckily, CWS Capital Partners is familiar with this and other important issues that can arise during a like-kind exchange, and partner with investors throughout the entirety of their exchange. Contact us today to start planning your next investment.
The information provided here is for your general informational purposes only. It should not be considered a recommendation or personalized advisory advice. CWS has made this third party information available from authors it believes are knowledgeable and reliable resources. However, its accuracy or completeness cannot be guaranteed and sentiment may change due to legal or economic conditions.
All investments involve risk including the possible loss of principal. You should familiarize yourself with all risks associated with any investment product before investing.
Advisory services are provided by CWS Capital Partners LLC, a registered investment advisor.
Securities offered by CWS Capital Partners LLC are through an affiliated entity, CWS Investments. CWS Investments is a registered Broker Dealer, member FINRA, SIPC.