Tax Guru – Ker$tetter Letter

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Is a 1031 exchange needed?

Posted by taxguru on July 9, 2007


My parents are both deceased and I am presently under contract to sell the farm.  I have made my intention to perform a 1031 exchange known to the potential purchaser.
I would like for you to advise me on the best course of action involving this matter.  My desire is to reinvest the  portion of the sale which would be subject to capital gains tax.
As a brief history; the farm was purchased in 1995, my mother died in May 2002, my father in  November 2003.
I have always lived here since 1995. 
I don’t know how to establish  the new value basis for the farm or how the exemption on the sale of my primary residence  will affect my overall tax liability.
The purchase price will be substantially more than average requiring, I believe, an exchange to avoid capital gains tax.
As it stands now the closing date could be anywhere from September  of this year to February of next year.  An investment group is purchasing the farm and other adjacent properties for a commercial venture and there are certain contingencies which make it impossible to know the exact closing date. 
So I  basically need to know where I stand so I will be prepared if the sale concludes as expected. 




It’s critical that you consult with a professional tax advisor because there are a number of issues that need to be considered.

First is the determination of your cost basis in the property in order to determine how much potential profit you would be looking at with a sale.  This depends on how you acquired legal title to the property, which wasn’t clear in your email. The three most common ways to acquire title would be by purchase, gift or inheritance.  Each one gives a very different cost basis amount.

For example, if you purchased it from them while they were alive, that would be your cost, plus improvements and less depreciation.

On the other hand, if they gifted the property to you while they were alive, their cost basis carries over to you even though Gift Tax returns are based on the property’s fair market value at the time of the gift.  If you received the property as a gift, you would start with their adjusted cost basis and add in any capital improvements and subtract any depreciation you have claimed to arrive at your current cost basis.

Finally. if the title to the property was transferred to you as a result of your parents’ death, your cost basis in it would be its fair market value as of the date they passed away, or an alternative date (usually six months later) if that was used on their estate tax return. 

If you did inherit the property, with the cost basis being established based on its value in 2003, your potential gain shouldn’t be as high as it would be if you had purchased the property or received it as a gift.

The other big issue that you need to work on with a professional tax advisor is how much of the property qualifies as your primary residence so that the sale price can be properly allocated between it and the farm portion.  As you probably know, up to $250,000 of gain from the sale of a primary residence is tax free; $500,000 if you are married.  I have a full explanation of this extremely useful tax break on my website.

I hope these points are useful in deciding if you have a tax problem to worry about, in which case a 1031 exchange would be a wise move.

Kerry Kerstetter




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