Can a 1031 Exchange Help in Tax-Smart Estate Planning?
Yes! Compared to selling a business or investment property outright, exchanging into a second property can result in significant benefits for your heirs.
1031 exchanges are well known for their tax deferral benefits — essentially, if you’re planning to sell one business or investment property and purchase a different property, structuring these two transactions as a 1031 exchange can enable you to defer capital gains tax and depreciation recapture tax.
However, there’s another benefit of 1031 exchanges that isn’t as frequently discussed: if you defer these taxes until the end of your life, your heirs’ step-up in basis typically eliminates the tax burden altogether.
Take the following example scenario: You own an apartment building which has appreciated in value by $1 million during the time you’ve held it. You wish to retire, so you plan to sell this property and invest the proceeds into a portfolio of income-producing stocks and bonds. At the time of sale, you owe 20% in capital gains tax, meaning your cash-out profit on the property is $800,000. Over the next decade, your investment portfolio provides a steady income and appreciates 25%. When you die, $1 million is transferred to your heirs.
Now let’s see what happens if you conduct a 1031 exchange with the estate instead: Your apartment building has appreciated in value by $1 million. Instead of selling the property outright, you exchange into another real property which provides lower-maintenance (or entirely passive ) income. Your capital gains tax is deferred, so you carry forward the full $1 million into the new property. Over the next decade, this property provides a steady income and appreciates 25%. When you die, $1.25 million is transferred to your heirs.
In this case, the difference to your heirs is actually larger than the amount of your potential tax burden at time of sale, because the amount you would have paid in tax can be left invested (and can therefore continue to appreciate).
A recent client of ours took this approach, exchanging her two properties for a triple net lease. When asked about her reasoning, she said, “I’ve reached a certain age where I no longer want to be in the business of property management. I have been in property management for the last 20 years and now want to generate a passive income for myself and my daughter, which is why I am working with Alan Fruitman to exchange my two properties in Palo Alto for a NNN property. Working with my attorney, we restructured my trust and gave my daughter power of attorney and made her beneficiary for that asset. I want to make sure she is taken care of after I am gone financially without the headache of taking care of an asset. The 1031 exchange was a viable solution for me to accomplish my investment and life goals.”
What can we help you exchange?
At JTC, we’ve put together an industry-leading track record of 1031 success, across tens of thousands of transactions and more than 25 years in the business. Our legal and Client Services team have decades of experience handling 1031 exchanges. And we’ve built a cutting-edge administration platform, called eSTAC®, from the ground up to maximize your transaction security and transparency.
If you’re considering a real estate exchange, you’ve come to the right place.