What to Do with Inherited Property – 1031 Exchange Tax Tips

So, David Moore with Equity Advantage, 1031exchange.com, and we’re going to talk about Inheriting Property today. And I was watching a video yesterday and it said, “Okay, if you inherit something, you gotta get rid of it immediately.” Well, there’s definitely reasons you might want to, but if it’s a great property, obviously why would you get rid of it?

And actually, I was looking at another topic online yesterday, I think they were talking about, “Well, should you do an exchange or a cash out re-fi?” And obviously, the old saying of, “Why would you ever sell a good piece of property” always is going to hold true, so that’s where that re-fi comes in, that cash out re-fi to give you the leverage, maybe it gives you the return you want. But the 1031 is going to be a question of whether you’ve maximized the value of that property.

Is there anything else you could do to it that would make it worth more before you get rid of it, or is it just something where you don’t want to change the area? But you’re always going to be looking at a choice, three to five years after acquisition of a property, your equity is going to reach a level that no longer makes sense to keep it, and you’re going to have that choice, “Do I do the exchange, or do I do the cash out re-fi?” And there’s reasons to do both. Even though you’re paying me to do an exchange for you, I’m going to tell you, if that property has got some other opportunities there, or if it means something in this inheritance context, why would you get rid of it?

So, when you inherit a property in today’s world, and we’re talking about September of 2022, stepped-up basis still exists, when you inherit a property, you’re going to receive that property at a stepped-up basis. What that means is, your mom might have paid $10,000 for a property, and it sold for a million dollars. You inherit that property, your basis on that property, if it’s worth a million at her passing is going to be a million dollars, so you could turn around the next day and pay no tax. So that’s why when you see some of these videos, it’s like you inherit a property, get rid of it. Well, yeah, if you don’t want it, or if you’ve got partners in that thing, and a lot of times if you own something with other people, you no longer want it.

A lot of times when people inherit things, they’ve got a bunch of siblings involved. I had a client a couple of days ago call up and say, “Well, look, we inherited this property a few years ago, but there’s three of us involved and a lot of difference in ages.” One of the siblings has no kids, the other one has a bunch of kids, and just for estate planning purposes, they want to fix this stuff, move it around. But when you inherit that property, I just want to stress again, you’re going to get a stepped-up basis, and if you sell immediately, you’re not going to have any tax. If you hold it for a while, then you’re starting to look at what happens with the market.

If you just inherited it, and we’re talking about selling it now, maybe it went down in value, but in a typical world, real estate has one golden rule, as an old buddy of mine used to say, “Don’t sell in a recession.” And it’s always going to work out if you hold the thing over time. So the benefit of receiving some things from inheritance, you get the stepped-up basis, and over time, hopefully, you’re going to be subjected to some increased values and therefore some capital gains. So if you don’t get rid of it immediately, you just have to look at what the gain is between that inherited value and what that thing is worth at the time you dispose of it in the future.

But inheriting a property is a great thing. That’s why we talk about swapping till you drop, and that’s a great, great tool. When people ask me, “Well, why would I do the exchange? I’m going to have to pay the tax at some point anyway. Why not pay it today?” and it’s a pretty easy thing to answer. It’s like, “Look, every dollar you lose to tax means $3 or $4 in reinvested fund, so why would you pay a tax you don’t have to?” And for those same people, I quite often ask, “Well, do you have an IRA? Do you have a 401K?” “Oh yeah, I’ve got an IRA, a 401K.” “Well, why do you have that? You’re going to have to pay the tax at some point anyway.”

I would say that 1031 is a much better thing because you always have the choice of doing the exchange, and if you don’t want to do the exchange, if you’ve held something for long enough, you’re looking at long-term capital gains tax rates, anything in a retirement account is going to be taxable when it comes out. It’s always going to be taxable at normal income tax rates.

You might say, “Well, David, what about a Roth IRA? That’s going to grow tax free. It’s taxed money that goes in that retirement account and grows tax free.” That’s a different situation, but still, even with a Roth IRA-owned asset, there are things that you’re not allowed to do. You can’t work on the property, for example. You can’t use it in any way nor could any other disqualified party.

So once again, we’re always going to look at what you’ve got, where you want to be in two, five or 10 years, and we’re going to help you to get there, but inheriting property, don’t feel like you gotta sell it immediately upon inheritance. If it’s a great property, keep it. Understand where that basis calculation is going to start at, that number when you receive it, and then over time, with any luck, it is going to go up in value, and you will be subject to pay that tax, if you don’t do an exchange in the future. So, hope this has helped. David Moore, Equity Advantage, 1031exchange.com, and look forward to talking with you soon. Bye-bye.