Remainderman inheritance transferred into 1031?

Question

When my grandmother died in 2002 she left her townhouse ($500k) as a life estate to my aunt for as long as she wants to live in it.  Should she sell it, it is currently on the market, I will receive 1/3, my father 1/3, and my aunt 1/3.

My internet research suggests that the basis of the property reset in 2002.   Additionally, only my aunt's third appears to benefit from the 250k capital gains exemption.

The house has appreciated approximately 300k in the last 16 years.  So, assuming I understand correctly, my father and I will each owe capital gains taxes (~20%) of ~$20k.

Instead, it seems like I might be eligible of using the 1031 exchange to roll over my 1/3 (~$165k) into the purchase of another property.

Does this sound right to everyone?

Michael Lynch · Answer

@Brighten Miller Unfortunately, that does not seem right to me. I do not see how you were using the house as a business (rental) asset, and that is a requirement for §1031. There may be an argument that this is investment property for you, but that seems like a long-shot and would warrant research.

If you are able to substantiate that this property is an investment property for you, there is another issue. There are revenue rulings about whether or not a remainderman interest is like-kind to other interest types. Again, would warrant research.

As an aside, since there are life estate and remainderman interests, are you sure each of you have one-third of the basis? And, are entitled to one-third of the proceeds? Usually time discounted calculations need to be made.

Dave Foster · Answer

@Brighten Miller, much is going to depend on the deed.  I"m not worried about the life estate for your aunt.  but it does make investment intent  murky.   If your cpa is ok with your investment intent ( it would have to be a hold for appreciation restricted by the life estate given to your aunt) and you are on deed to the property then yes you and your dad both would be eligible to do 1031 exchanges either together or separately on your % interest.  @Michael Lynch hit on all the right issues.  I'm not quite as pessimistic on the investment intent.  Production of income is not a statutory required qualifier.   Holding for appreciation is fine as long as there was no or very limited personal use by you to muddy the water.  The life estate could also be seen as an artificial limitation to your investment activity.  Food for thought on both sides.

Brighten Miller · Answer

@Michael Lynch ahh.. that makes sense.  I forgot about the "like kind" requirement.   Thanks for the answer.  Guess I just get to suck it up and prepare to pay a bunch of taxes.

Brighten