Structure a sale to avoid taxes upon death of seller?

Question

Hi all,

I'm in an interesting situation. Long story short, a 94-year-old woman has expressed interest in selling me her $2M duplex (in a very nice area of Los Angeles, hence the $2M price tag). I haven't dug into her motivations yet, but I can think of 20 reasons why she wouldn't: her adult children and adult grandchildren.

What I do know is this: if the potential seller put her duplex into a trust and named a beneficiary, the beneficiary would inherit the duplex with a stepped-up cost basis. He/she could sell it immediately and pay basically no taxes.

A few other facts I know: the potential seller owns the duplex outright. She resides in it. She owns it in her own name, not in a trust. She's owned the duplex for 49 years, so her cost basis must be $100k, if not less. She owns other property nearby, so I believe she's financially comfortable.

Here're my questions: how can I structure the sale such that the potential seller and/or her children aren't stuck with a huge tax bill? Is there a seller-financing option that reduces the tax bill if her children inherit the note? Is it possible for her to put the duplex in a trust, sell it to me, and then keep the funds in the trust until a beneficiary takes over the trust? And what the tax implications there?

Any advice from a knowledgable tax specialist would be greatly appreciated! I don't want to buy this duplex if it's not in the selling family's favor in some way, so I want to come prepared with some win-win scenarios.

Thanks so much!

Jonathan

Eamonn McElroy · Answer

@Jonathan Schwartz

Let's examine....

If it's her primary residence and she's not MFJ she gets a $250k exemption on the capital gain.  If she's owned the unit for 49 years she definitely has some improvements that should be capitalized into adjusted tax basis that will further reduce gain.  Any remaining capital gain might be able to be deferred with an opportunity zone investment.

You did not state if the other unit in the duplex is empty, being used by her, or being rented out.  If is being rented she may be able to do a 1031 exchange on that portion.

If she is willing to move out and rent out both sides of the duplex for a couple of years, there's a rev proc out there that will give her safe harbor on a 1031 for the whole property as long as she holds the new property(ies) for a couple of years.  This may not be advisable given her age...

Or, as @Jay Hinrichs mentioned, let the kid(s) inherit it and buy from them.  There is elevated risk here.  I don't particularly like this approach unless you have a strong relationship with all of her children and heirs.

I think what a lot of us are getting at is that if you are the buyer and NOT advising her on tax matters -- all of this planning is moot.  You should be focused on drawing up a deal and closing, and to a smaller degree what the tax impacts are to YOU.  She should be listening to her independent counsel and coming back with a counter offer.  You don't want the kids coming after you later down the road for any real or perceived issues surrounding the sale...

Jay Hinrichs · Answer

PS s normally when I dealt with this again in timber lands as the owners generally were elderly..  you waited until they passed and then the kids get the stepped up basis so we would try to create relationships with the future heirs and let them know who we are and what we could do with the timber.

its the heirs that get the stepped up basis so just buy it from them sometime in the future ?

Dave Foster · Answer

@Jonathan Schwartz, Steve Vaughn took the words out of my mouth.  Lease one half and move into it at a negotiated rate.  Get an option to purchase for $2 mil.  If you want to create an option that takes into account your lease payments (be careful here creating a beneficial interest inadvertently.  You just house hacked for a fraction of the $ 2 mil cost.  You get the property eventually.  Her heirs have the chance at the step up in basis.

Or, if the duplex can be divided buy the half she lives in now and let her take the primary residence exemption for that half.  If she is using both halves then you may be able to buy the vacant half and still do the same.  Again, get an option on the other half.  Live in half and wait for time to take care of the other half.

Steve Vaughan · Answer

Obtain an Exclusive Option to buy maybe, if buying below market value.

I have an old seller I'm trying to get to do this with. I agreed to not exercise until it hit his estate.  May give her comfort knowing the details are ironed out and heirs will still inherit at stepped up basis.

Jay Hinrichs · Answer

how does it affect you.. its a 2 mil property your paying 2 mil for what is the upside.. unless of course your low balling and taking equity from the sweet little old lady :).. don't see your point in all of this.

I dealt with this in the Timber business were many of my clients owned timber with next to zero basis.. we did a 1031 on the timber deed.

if she lives there I don't think she can 1031.

she can do a charitable remainder trust but really she is too old for that.

and I think there are things called generation skipping trusts.. I have heard that one before

but really like mentioned above she needs to talk to her council.

at least she gets either 250 or 500k tax free.. on the owner occ exemption if in fact she lives there.

Joe Scaparra · Answer

Ok, this opens a can of worms, be careful or you just might lose the sell altogether.  I don't understand your motivation unless you are afraid that the woman selling is not of right mind and the children may come after you buy.

Questions?

Does the lady selling even want you involving the children?  By your own admission, her son is a 70-year-old CPA with decades of experience but for whatever reason, she doesn't want to consult him.......hmmmmmm.  Involving the children may give them their own ideas as to what to do with the property.

Why do you not want her to handle her own business?  Shouldn't you just concern yourself with your side of this offer?

Sounds like there are some family dynamics that you are not privy to.  I say worry about your offer and let the chip fall as they may.    Good luck, Cheers.

Jay Hinrichs · Answer

but the seller will owe tax on the installment sale.. and the tax will be based on the gain.. but again not an expert for sure..

good luck with it..  you know for 2 million you could buy 25 duplex's in the mid west LOL.. but then you would have to live there right ?

Eamonn McElroy · Answer

@Jonathan Schwartz

Kudos to you for trying to help her out, but she should really be engaging a CPA on her end.  It seems like you're going to try to advise her on tax matters, and by doing that you'll open yourself up to liability -- which may not look that good considering you are the buyer and have a conflict of interest.

There are options depending on her goals and the timeline involved...heavily depends on her goals and what she wants to do in the short and long term.

Eamonn McElroy · Answer

@Jonathan Schwartz

"I'm pretty sure that an heir can inherit a promissory note and only pay taxes on the interest income. Anybody know more about this?"

An installment sale is not considered a disposition upon death except in limited circumstances (i.e. unrealized capital gain on the installment sale is not recognized in gross income by the estate).

The heir steps into the shoes of the decedent and continues reporting interest and capital gain.

Jon Schwartz · Answer

@Eamonn McElroy, hear you loud and clear. Thank you!

Structure a sale to avoid taxes upon death of seller?

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