Estate Planning Considerations with Community Property States

In the realm of estate planning, many taxpayers don't really have their estate plan in place before they've sold their relinquished property. In the course of doing the organizational work, they may ask “can John Doe sell his relinquished property and have John Doe as Trustee of his own grantor revocable trust receive the replacement property?”

Generally, a revocable grantor trust is going to be running under the same social security number as John Doe in this hypothetical and it's going to be considered a continuation of investment by John Doe.

The same goes for a single-member disregarded entity such as a pass-through LLC that is wholly owned by John Doe. That would be another suitable way to acquire the replacement property.

Community Property States

Many of our clients have amassed wealth in real estate over a long period of time and now they're in their golden years and they may have moved to a community property state such as California, Texas, or Wisconsin. Does a taxpayer’s step-up in basis change if they’ve relocated to a community property state?

The short answer is yes. How assets transfer in terms of your estate plan are impacted by the local law and also by the federal and state taxation scheme.

So stepped-up basis is something that is a local concern as well as a federal concern. If you change your residence you need to make sure that you consult with local council to confirm that your current estate plan is valid.

Minnesota Property Considerations

In some states (like Minnesota) a lot of residents attempt to modify their residence for purposes of taxes by becoming snowbirds and permanently residing in Florida (for example) but continuing to own Minnesota real estate in pass-through entities. The current Minnesota estate tax treats any real estate owned that is located in Minnesota as a Minnesota taxable asset. So even though you are a Florida resident, if you own an apartment building or other type of real estate in Minnesota either in your individual name or in a pass-through entity, you will potentially be subject to a Minnesota estate tax.

• Start Your 1031 Exchange: If you have questions about 1031 exchanges, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2021 Copyright Jeffrey R. Peterson All Rights Reserved

How Long Can You Wait to Identify Your 1031 Exchange Property?

In a 1031 exchange, is it possible to sell your relinquished property first and then identify your new replacement property? The short answer is yes. You can fly by the seat of your pants and wait until day 44 in your identification period to really hone in on what you want to identify.

Do Your Homework Early

However, if you do your homework early, even before you sold your relinquished property and started to think about your replacement property options, you will benefit from that homework because it is a very tight market. If you want to go back into traditional brick-and-mortar property, it is a very competitive market and wouldn't it be nice to have a purchase agreement already in place on your replacement asset?

That way when you identify you have the certainty that you're going to be able to acquire it. It can't be sold out from underneath you because you have it under contract.

Many people get locked up with paralysis and they can't decide what to identify. Meanwhile all the other buyers in that Marketplace are gobbling up the available inventory. In places with very competitive real estate marketplaces people are making offers sight unseen at full price.

Think Like a Chess Player

You really need to think ahead like a chess player if you want to be able to navigate these issues. That said, you can wait until the 45th day do identify and designate your official 1031 exchange replacement property. But a pro tip is to plan ahead so that this is a less stressful process.

• Start Your 1031 Exchange: If you have questions about 1031 exchanges, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2021 Copyright Jeffrey R. Peterson All Rights Reserved

Can You Be Reimbursed for 1031 Expenses Paid from the Qualified Intermediary?

Can you be reimbursed for expenses paid during your 1031 exchange from the qualified intermediary? That’s a very common question that many taxpayers have when conducting 1031 exchanges of real estate.

Transactional Expenses

Let’s say that during the 1031 exchange process, you had expenses for surveys, appraisals, or other items that you paid for out of your own pocket. Is it possible to get reimbursed for these expenses from the qualified intermediary?

The gain that a person recognizes on a 1031 exchange would be equal to the gained deferral or the boot received (the lesser of the two). If an individual is putting money into their exchange and taking money out of that exchange, you can net those funds for certain transactional expenses.

Here’s how a lot of taxpayers approach this. They have a duplex they want to sell and they spend $12,000 touching up the duplex and getting it ready for sale. When the duplex sells, they want to reimburse themselves for the $12,000 that they had paid in repairs to get it ready for sale. That's where people can get a bit greedy when they want to reimburse themselves for all these expenses.

The Better Play

The better play is to only pay transactional costs that are customarily seen in that locality. If you have an attorney's bill, and accountant’s bill, a real estate agent’s bill, recording fees, etc. – those are the kind of expenses that would be permissible to pay out of the 1031 exchange proceeds.

It is a good idea to involve your attorney and accountant as early in this process as possible. As you can see there are a lot of potential landmines you can step on during a 1031 exchange. Involving your team of professionals as early as possible is the best way to ensure the success of your 1031 exchange.

• Start Your 1031 Exchange: If you have questions about 1031 exchanges, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2021 Copyright Jeffrey R. Peterson All Rights Reserved

Why to Consider 1031 Exchanges in Your Estate Planning

When you inherit a piece of property upon the death of a grantor, you receive that property with a step-up in basis. You can receive that inherited property and instead of having the decedent's low basis during their lifetime the basis gets stepped-up to the fair market value at the time of their death, generally speaking.

So rather than sell the property and unnecessarily trigger the recognition of gains in your latter years, many taxpayers who own property instead consider taking their gains with them to the grave. You have to stop breathing for this plan to work, but when you do, then your kids can inherit the real estate with the stepped-up basis.

When Descendants Don’t Want to Inherit Property

One thing I've noticed in my many years helping taxpayers with 1031 exchanges is that for a lot of people who have made money in real estate, their children don’t necessarily wish to inherit and deal with their property. These descendants are often in high-performing professions such as doctors, or lawyers, and they're busy with their careers and have no interest in their parent’s real estate holdings.

Consider a 1031 Exchange

In some cases they just don't have any interest in real estate because they watched their parents toil and labor and suffer with the demands of owning a piece of real estate and they don’t have any interest in repeating that story themselves. These are just some of the challenges with estate planning and thinking about the next generation because the kids may not have the aptitude or the desire to take on that responsibility of the inherited property. If this is the case, a good alternative option would be to 1031 exchange out of the management intensive property and into something less management intensive.

• Start Your 1031 Exchange: If you have questions about 1031 exchanges, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2021 Copyright Jeffrey R. Peterson All Rights Reserved

What Exactly is a 1031 Exchange?

Section 1031 is a provision in the tax code that allows you to defer your recognition of gain of taxes when you're selling investment or business property, typically through a qualified intermediary.

What Property Does & Does Not Qualify for 1031 Exchange

A litmus test to see if you qualify for 1031 treatment is that both the property being disposed of and the property being received has to be real estate that's held for investment or business purposes or for use in your trade.

Things that don't qualify for 1031 exchange include flipped properties or personal use properties like your home, your cabin, or a second home that's used primarily for personal use. Those types of property don’t fit into the paradigm of 1031 exchange.

Another interesting facet of a 1031 exchange is that it is an exchange. That means the same taxpayer that sold the relinquished property has to be the taxpayer that receives and completes the circuit by acquiring the replacement property. It's an exchange of asset A for asset B.

1031 Exchange Obstacles

Mechanically, there are some potential barriers or obstacles to doing a 1031 exchange that are written into the regulations. One such obstacle is that you have to identify the replacement property within 45 days after the date of the closing of your relinquished property and you have to receive the replacement property within 180 days of the disposition of the relinquished property. These two timelines run together after the date of closing of the relinquished property.

In a hot real estate market it is hard to find replacement property and that 45 days goes quick. When we talk about estate planning we need to be thinking like a chess player (two moves ahead), meaning you need to be able to identify your replacement property, designate it within 45 days, and receive it within 180 days.

• Start Your 1031 Exchange: If you have questions about 1031 exchanges, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2021 Copyright Jeffrey R. Peterson All Rights Reserved