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Let me state that question more thoroughly--WHAT HAPPENS IF THE TAXPAYER DIES AFTER COMPLETING THE SALE OF THE RELINQUISHED PROPERTY, BUT BEFORE THE PURCHASE OF THE REPLACEMENT PROPERTY? There that sounds better. The answer to the question has been spelled out in an old Revenue Ruling (Rev. Rul. 64-161)--AND- the answer is: The taxpayer's estate can still complete the exchange and close on the purchase of the replacement property, should they so desire.
Let me emphasize, that after talking to your financial/tax advisor, you will discover that with their help and proper estate planning, you may NEVER have to pay any Capital Gains Taxes.
There are numerous tax planning vehicles available, such as gifts to others, irrevocable trusts, charitable contributions and best of all, proper estate tax planning, that allows your assets to be delivered to others without ever having to pay taxes. Remember that your heirs will receive your assets from your estate at a "stepped up basis" in fair market value.
What does that mean? It means that your heirs will receive your assets tax free, provided those assets do not exceed the statutory exclusion figures. At the present time, the exclusion figure will be accelerating up to $3.5 million in the next two years and that's per person.
So proper planning under today's law could allow up to $7 million per couple tax free to your heirs. Congress will have to address the estate tax exclusion issue in the next two years. Insiders say that Congress will either approve $3.5 million per person with a CPI increase per year exclusion, or increase the estate tax exclusion up to $5 million per person--Most tax practitioners are waiting with baited breath to see how this issue is resolved--but it looks like both the Republican and Democratic Congressional leadership are close to agreeing on these figures.
In the recently released report (2008-30-154) from TIGTA (Treasury Inspector General for Tax Administration), gave a good basic background on Section 1031.
Treasury stated: " Under normal circumstances, when a taxpayer sells business or investment property and realizes a gain, tax must be paid on the gain at the time of the sale. A like-kind exchange allows for an exception to the payment of the tax on the gain. When taxpayers exchange business or investment properties for like-kind business or investment properties, they can defer payment of the tax on the gain. As long as a property used for business or investment is replaced with a similar property, no gain or loss is recognized at that time. Instead, it is deferred until the eventual sale of the replacement property.
Taxpayers who take advantage of like-kind exchanges increase their purchasing power, as well as their financing and leverage capabilities, because payment of Federal tax on the gains is deferred. Taxpayers can use exchanges to acquire replacement properties with greater income
potential (e.g., raw land can be exchanged for income-producing property and qualify as a like-kind exchange).
With additional equity to reinvest, taxpayers can execute exchange after exchange and continue to defer payment of tax on the gain realized. The tax liability might be forgiven upon the death of the investor because the heir(s) might qualify for a stepped-up basis on the inherited property. While the concept of trading one property for another similar property might seem straight forward, the tax rules governing such transactions are firm and need to be closely followed. For example, strict timing rules require a taxpayer who trades property to identify, in writing, the replacement property within 45 calendar days and to complete the entire transaction within the earlier of 180 calendar days after the sale of the exchanged property or the due date, including extensions, of the income tax return for the year in which the relinquished property is sold. Strict rules also prohibit taxpayers from taking control of cash or other proceeds before the exchange is complete. "
I love acting as a QI (Qualified Intermediary) and yes there are a lot more additional complex rules than those stated above--but it is truly a great feeling when you can help someone defer and possibly never pay taxes, LEGALLY--that's why I love my job.
This is hot off the presses--literally--although the report from TIGTA (Treasury Inspector General for Tax Administration) is dated August 27, 2008, it just was printed and confirms what I have been saying about the growth in the Section 1031 industry-- I quote: "Driven in large part by the rise in real estate prices, the number of like-kind exchanges more than doubled between Tax Years 2001 and 2005, according to IRS statistics. In Tax Year 2005 alone, the IRS recorded deferred gains of approximately $101.3 billion from 429,000 like-kind exchanges.
Qualified Intermediaries can assist taxpayers in completing a like-kind exchange by receiving and holding the proceeds for the relinquished property and then disbursing the funds to acquire the replacement property. " In running one of the largest QI (Qualified Intermediary) companies, I have seen the growth over the past few years, even in a down economy--but it's good to see it reaffirmed in print by Treasury.
In order for there to be a valid 1031 exchange, title to the replacement property must be held in the same taxpayer as the one who sold the relinquished property. Sounds simple doesn't it. Mr. Jones sells his relinquished property --- and therefore Mr. Jones must be the purchaser of the replacement property. XYZ corporation sells it relinquished property and wants to do a Section 1031 exchange. In that case, XYZ corporation must be the titleholder on the purchase of the replacement property.
But what happens if title is in the name of Mr. Jones and the new lender on the replacement property wants his wife, Mrs. Jones, to be placed on the title, as Mrs. Jones has better credit than Mr. Jones? This makes for a difficult Section 1031 situation, because the lender is requiring that title to the replacement property, not be in Mr. Jones's name, but in both their names, which is not how title was held title on the relinquished property. Yes, this definitely creates a problem in the Section 1031 arena and probably will deny the use of Section 1031.
There is an exception. Should the taxpayers (Mr. and Mrs. Jones) live in a community property state, they are allowed to transfer the Section 1031 property held in just one of their names and purchase a replacement Section 1031 property in both of their names. Therefore, in a community property state, a Section 1031 exchange would be viable. But that is not a solution for those taxpayers that do not reside in a community property state.
What happens if the taxpayer held title in his individual name and then wants to put title of the replacement property in the name of a single member LLC? The good news is that is OK--- because a single member LLC is "disregarded" for Federal tax purposes. Of course the taxpayer must be the only member of that single member LLC. As in the past, I always recommend that the taxpayer discuss these issues with their tax or legal advisors. Of course we too are also always here to help.
I realize this has nothing to do with Section 1031--but every once in awhile, I throw in an additional consumer oriented item. The following is an excerpt from a newsletter I received-the subject-- Password Protection.
"Passwords are crucial to accessing your personal accounts and information. The problem is: We all have so many accounts that we worry more about remembering our passwords than we do about making sure they actually protect our data from hackers. So we end up using passwords like our mother's maiden name or child's first name. But even if you add a few numbers to the end, those types of passwords are easy to break. And that means your data isn't safe. The tips below can help you avoid the most common password pitfalls and even implement a few new ideas that will make your passwords easy to remember...and hard to break! A well-protected password is not only unique, but also hard to guess. How do you do that? It's pretty simple really. Just follow this advice:
Multiplication Facts--Most of us cheat when it comes to passwords. We have trouble remembering our passwords, so we come up with two or three that we can remember and use them everywhere. But you should avoid the temptation. The fact is, once a password is compromised, all of your accounts are vulnerable. There's no way around it, you need to a way to create and remember multiple passwords--a different one for each account!
Sure-Fire Technique for Memorable, Unique Passwords--For all the advice above, good passwords come down to two things: they're easy for you to remember, and they're hard to break. Implementing the tips above can make your passwords hard to break, but what about remembering them--especially if you have a unique password for every account? Here's a sure-fire tip to help! 1. Think up a phrase. Instead of a common word or family member name, think up a unique phrase that only you know. For example, you may think up something off the wall such as "I Like Short Hair Too." 2. Make it an acronym. In our example, "I Like Short Hair Too" would become ILSHT. 3. Add Complexity. Remember those substitutes you're not supposed to use with dictionary words? Well, you CAN use them with your acronym. For example, "I Like Short Hair Too" can become "1 Like $hort Hair 2" which makes: 1L$H2. You can also use upper and lower letters to make it 1L$h2. The point is to be creative, but in a way that you can easily remember it. 4. Make it unique. A password is only really unique if you use it for one account and one account only. So you can't just use 1L$h2 for every account. And, in reality it's still too short. Here's the key to the whole process: Mix in additional letters and numbers that are unique to each account. For example, if you're logging into a "gmail account" you can use the "gm" and "@cct" (for acct) to make: 1L$h2gM@cct. Then, for a Netflix account, you may use: 1L$h2Nf@cct.
Of course, these are just examples. You'll want to be creative and think up your own acronym and ways to add unique characters for each account. And then keep that little secret to yourself so no one will be able to guess your account passwords. Follow these simple steps and you'll have passwords that are tough to break, unique to every account, and easy to remember!"
Yep, the IRS Regulations specifically suggest that any taxpayer wanting to defer their taxes should have an independent QI as part of the transaction. More importantly, all funds must be disbursed to the QI (Qualified Intermediary) and not to the taxpayer or any of its agents. Should the taxpayer have the funds transferred to itself or any of its agents, they will be taxed as receiving the funds. I received a telephone call from a prospective client that closed on the sale of their relinquished property 2 weeks ago but still wanted to do an exchange. TOOOO LATE !! The taxpayer and it's agents touched the funds(in this case the taxpayer had actually deposited the proceeds of sale into its own checking account). TOOOO BAD!!--That's why I always suggest that you select and get your QI involved in the process as early as possible.
A successful 1031 exchange allows the taxpayer to defer all of their Federal, and in most states, capital gains and depreciation recapture taxes on the sale of their investment property or property used in their trade or business. We have discussed in other blogs the time limitations, the need for the use of an independent Qualified Intermediary and the "Napkin Rule". For those of you that want a refresher, either go through our previous blogs or you can go to our website to get that information.
But there are some other basics that must occur in order to have a valid Section 1031 tax deferral transaction and they are: (a) The Taxpayer must acquire a "like kind" replacement property that is at least of equal value or more than the property they sold (the relinquished property); and (b) The Taxpayer must use (invest) all of the net proceeds received from the sale of the relinquished property towards the purchase of the replacement property. It is always recommended that the taxpayer meet with their legal and financial advisors when doing any type of real estate transaction and of course this holds true when they are contemplating a tax deferred exchange.
The rule is that the taxpayer can exchange any piece of real property or personal property, located in the United States(domestic property), that is an investment or used in a trade or business, for "like kind" property located anywhere in the United States(domestic property). In other words, domestic property exchanged for another domestic property. What about exchanging a domestic property for a foreign property or vice versa? Nope, foreign (non-domestic) property cannot be exchanged for a domestic property, but a foreign property can be exchanged for another foreign property, as long as they are "like kind". So you can exchange (subject to the other Section 1031 rules) a piece of investment property located in Arizona for a piece of property in Vermont, but cannot exchange it for a piece of property in Paris, France. Now that Paris, France property can be exchanged(subject to the other Section 1031 rules) for another "like kind property" in another country. Example: Paris, France property for one in London, England.
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