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Is 1031 allowed on recently inherited property?

Technical topics regarding tax preparation.
#1
Wiles  
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Two brothers each own 25% of bare land held for investment purposes. Their father owns the other 50%, which is also held for investment purposes.

The father passed away in 2017 leaving the property to the two brothers equally. During the father's trust administration, the brothers were approached by a prospective buyer. The trust's 50% interest in the property was transferred to the two brothers in July 2019 and two months later went into contract with the buyer.

The brothers each desire to do a 1031 exchange. They have appreciation in both their original interest and in the inherited interest.

Is there a problem exchanging the inherited interest because they did not hold it 'long enough' prior to selling it?
Last edited by Wiles on 13-Sep-2019 4:24pm, edited 1 time in total.
 

#2
Doug M  
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I would argue that the property was owned by the brothers on the date father passed. Was there any reason why it took so long to transfer title? Was it a question of ownership, etc? Or just the trust admin/probate process?
 

#3
Wiles  
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Just trust admin process took a while. Nobody was in any hurry. Brothers knew they wanted to sell the property all along and were waiting for a buyer to make this task a priority.
 

#4
Doug M  
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In the realm of "holding periods" the date acquired would be date of death. If mom dies on 1/10/18 and the property is distributed to the beneficiary 7/10/19, you would use 1/10/18 as date acquired.
 

#5
sjrcpa  
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Inherited property is deemed to be held long-term.
 

#6
Wiles  
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Yes. But that is for purposes of determining LTCG vs STCG. The same is true for property distributed out of a partnership.

The holding period rules for purposes for qualifying for a 1031 exchange are different.
 

#7
Doug M  
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Aren't the two brother's getting K-1's (2017/2018/2019) with rental real estate income from this property?
 

#8
Doug M  
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One other thought. Bifurcate the sale into two separate transactions on the 1040?
 

#9
Wiles  
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Why?
 

#10
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I think what Doug is getting at is that the inherited portion might not have a lot of gain imbedded in it, so if these guys want to cash out the inherited portion, because they don’t want to maintain such a large investment in, say, one replacement property, perhaps they could do that. They might want to diversify out into other asset classes. Or, he might be suggesting that you could do two exchanges. If one exchange gets busted (the inherited one), the gain might be lower than it would be if the all properties were exchanged in a single exchange. Just guessing.

I’m not sure how much appreciation is in the inherited portion…but there might be some immediate appreciation, when combined with the previously owned portion, since the inherited piece DOD value may have reflected a fractional interest discount. The same can be said for the portion owned by the brothers.

In any case, I think the facts are pretty strong in your case. For one thing, the brothers already owned an interest in the same parcel, which was held for investment. And second, the inherited piece wasn’t converted to personal use. It reminds me a bit of a decedent’s personal residence. If that property isn’t converted to personal use, it’s investment property. Third, the fact is, the inherited property has risen in value since death, which is what everyone wants out of their investments.
 

#11
Wiles  
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Found this prior discussion with a similar question: viewtopic.php?f=8&t=6649

Included in that discussion was a reference to PLR201812012 PLR 200812012.

In this case, Trust terminated involuntarily by its own terms after many years in existence. Because Trust was a testamentary trust, the termination date was fixed by Decedent and could not be modified or changed. The Plan of Termination was approved by the State A Probate Court and would have occurred without regard to whether this exchange of properties had been consummated. Consequently, the like-kind exchange in this case was wholly independent from termination of Trust, and thus LLC's acquisition of the Replacement Property in a reverse like-kind exchange was wholly independent of its § 708(b)(1)(B) termination. Moreover, there has been no change either in the beneficial ownership of LLC, or in the way it holds or manages the Replacement Property. It has continued to own this property for investment purposes. Thus, the facts in this ruling request are distinguishable from those in Rev. Rul. 75-292 and Rev. Rul. 77-337, which involve voluntary transfers of properties pursuant to prearranged plans.

This particular situation includes the extra protective layer of holding the real estate in an LLC. The trust distributed the LLC interest to the beneficiaries. The LLC conducted the exchange.

However, the IRS does put value on 2 things here:
1. The trust termination is involuntary.
2. The transfer out of the trust is independent of the 1031 transaction.
Last edited by Wiles on 15-Sep-2019 8:50am, edited 1 time in total.
 

#12
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First, get your citations right. Second, I think there is plenty of case law that pushes back against the idea that when one acquires property, and pretty quickly exchanges it, that doesn’t necessarily mean the relinquished property wasn’t held for the requisite use. Said case law pushes back against the idea that we have investment property, rental property, business use property, and this weird class that is a class unto itself: Property Acquired With The Intent to Exchange It. This push-back case law says if the intent isn’t to liquidate the property and isn’t to use it in personal pursuits, it’s qualifying property. In any case, I’d said the death of the property owner is about as involuntary as you can get. I think you have easy facts and I wouldn’t bat an eye at going through with the exchange.
 

#13
Wiles  
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Thank you, Jeff. I fixed the citation.
 


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