What do you do if you're doing a 1031 exchange and the taxpayer dies in the middle of the exchange? In other words, after the disposition of the relinquish property, the taxpayer that's conducting the exchange dies - what are your options in that scenario?
Let the Exchange Fail
One possibility is you could just decide to have the exchange fail and return the unused proceeds back to the estate. The personal representative of the estate will then file a tax return for the final year of the deceased’s life, and show that the sale occurred and they realized all of the gain on the sale of the property. That would probably be the most tax inefficient treatment. A fate almost worse than death.
Continue the Exchange
The other possibility is that the personal representative could continue to complete the exchange and purchase replacement property of equal or greater value/equity and offset the debt relief so that when they file their final tax return they don't recognize any gains on the disposition of the relinquished property and the personal representative does have to send any checks to the IRS for the sale of the relinquished property.
For the heirs that are inheriting that replacement property they are receiving the replacement property with a stepped-up basis which means the basis is increased or stepped up to the fair market value at the time that it is appraised for estate tax purposes. So we are deferring the tax in the estate and then the entire tax liability dissipates when the basis gets stepped up. To the heirs that is a double play that is outstanding and can save them a lot in taxes.
- 1031 Hotline: If you have questions about what happens when a taxpayer dies in the midst of a 1031 exchange, feel free to call me at 612-643-1031.
Defer the tax. Maximize your gain.
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