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INHERITANCE VS. GIFT: TAX IMPLICATIONS AND WEALTH TRANSFER STRATEGIES
Not sure how to transfer property to your heirs? Below are two of the most common options for transferring real property. Each option has a unique impact on the 1031 Exchange.
Option 1: Gifting investment property involves giving the property to another person during the owner’s lifetime. When a gift is made, the donor is generally responsible for paying any gift tax due on the transfer. In addition, the recipient of the gift receives the property at the donor’s cost basis, which means that any capital gains tax liability that has built up over the years will be the responsibility of the recipient if the property is sold in the future. This can result in a potentially significant tax liability for the recipient, and make it more likely they will need to do a 1031 Exchange when they sell it in the future.
Option 2: Receiving a step-up in basis at death involves inheriting property from a deceased owner. When a person inherits property, the property receives a step-up in basis, which means that the cost basis is adjusted to the fair market value of the property at the time of the owner’s death. This step-up in basis can significantly reduce or even eliminate capital gains tax liability if the property is sold in the future.
In other words, if a person gifts investment property during their lifetime, the recipient will have to pay any capital gains tax liability if they sell the property in the future. If the same property is inherited after the owner’s death, the recipient will receive a step-up in basis, potentially reducing or eliminating any capital gains tax liability. It’s important to note that both gifting and inheriting property can have complex tax implications, and it’s essential to consult with a qualified tax or legal professional to ensure that all tax laws are followed and that the most advantageous approach is taken for your specific situation.
Tip: If property was not inherited recently, it may have accrued capital gains and a 1031 Exchange may still be advised.
It's important to note that a 1031 exchange can be complex, and it's important to consult with a tax professional and qualified intermediary to ensure that the exchange is conducted properly and in compliance with IRS guidelines.