1031- Tax Deferred Exchange

Under previous law, inherited property was given a full stepped-up basis for tax purposes -- the value of property on the date of death was considered the “cost” basis for the beneficiary. Under current law, if a parent paid $300,000 for a home and the value of the home on the date of the parent’s death was $1.5 million only $1.3 million can receive step-up treatment. Therefore, the beneficiary inherits the decedent’s cost-basis above $1.3 million (or, $200,000 in this example). Surviving spouses can step-up an additional $3 million. That’s going to create a taxing situation for thousands of moderately well-off families in 2010.

If Congress passes retroactive legislation, prior court cases suggest that restoring the estate tax is legal. If Congress takes no action, the top rate on long-term capital gains will remain 15% in 2010, but will automatically rise to 20% in 2011. The estate tax will then have a $1 million exemption and the tax on the remainder will be 55%.

With estate and capital gains taxes expected to return in 2011 (at the unfavorable rates that applied 10 years earlier), heirs may find a §1031 Exchange a viable option for deferring capital gains taxes upon inheritance of real property.

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