How to Find "Cost" Basis for Inherited Land prior to 1031 Exchange?

Question

I inherited 62 acres of land in Middle Tennessee back in 2017. I would like to subdivide the land into smaller 5 acre tracts, sell them, then complete a 1031 exchange.

My CPA asked me what the "basis" in the property is. I understand the concept insofar as if I'd purchased the property, the basis would be what I'd paid it. However, because it was inherited, I didn't pay anything.

So, I believe the basis would be what the value of the land would've been when I inherited it. How do I research or find sales comps from previous years, for example 2017-2018?

Is it simply that I find the average sales price of a 5 acre tract of land within a specific radius of my property in the year that I inherited it?

Dave Foster · Answer

@Richard Benjamin Wilhite, A great place to start would be the county appraiser records. You can find comparable sales in 2017 and use that dollar/acre figure to arrive at the fair market value then. The executor of the estate also should have had some basis for that as well. Fair market value when your relative passe as @Jake Baker and @Cory Carlson said.

Jake Baker · Answer

@Richard Benjamin WilhiteSince you inherited the land, I believe your cost basis is typically the land's fair market value at the time of inheritance. If an appraisal was done at the time of inheritance (e.g., for estate purposes), that value would serve as your basis.

Cory Carlson · Answer

Your basis is the value of the property at the time of inheritance. A broker will be able to help you determine the value of the land. It would be wise to ask your CPA the capital gains exposure once this strategy is being executed. For example, if the land was inherited with a value of $1,000,000 in 2017 and you split off 12 lots that sold for $200k each. What would the capital gains be on the sale of each lot? Sometimes it makes sense to pay the gains if there are not adequate replacements. Sometimes it makes sense to have a back up plan for a DST. Sometimes the long term capital gains are palatable and it may make sense for you to pay the tax rather than force a bad deal. That is subjective though - I just advise my exchange clients to understand that number and understand their exposure. I find it silly when sellers force their exchange for an underperforming deal just to avoid $25k of taxes.

Bill B. · Answer

It would/could be only 15% capital gains tax and yes you could/would deduct all selling costs including commissions and transfer taxes. If you didn’t think $6k was worth it you might find it’s under $5k. And then if it costs you $1k per lot for 1031 exchange it might be under $4k. Even less if splitting the lots costs any real money. And that’s if you can’t find something to buy for under $100k or time multiple sales at once. Is there a local developer/builder who might be interested in the whole package? You might make less, but you cut a lot of costs, make the 1031 exchange easy and maybe worthwhile.

Richard Benjamin Wilhite · Answer

Cory, I very much appreciate your response. You're right, I definitely do not want to force a bad deal just to avoid a relatively small amount in taxes.This morning, I spoke with the property assessor’s office in the county where my property is located. The assessor was able to look up the market value of the land in 2018 when I inherited the property, which came to $13,500 per acre. Today’s value is somewhere between $19,500 - $22,000 per acre. I was planning on the selling the land in 5 acre tracts, so each tract would roughly sell for approximately $100k. So the basis in each tract would be $67,000? And I’d owe capital gains tax on roughly $30,000?Or would it be minus realty fees and closing costs as well? The tax rate would be 20%?In any event, that would mean I’d owe the IRS approximately $6k on each tract of land that I sold? It doesn’t seem like a large amount. If this is the case, perhaps a 1031 exchange wouldn’t be worth it. What are your thoughts?

Henry Clark · Answer

Typo. 1031.

Henry Clark · Answer

OP. Sit down with a 1032 Accommodator and have them explain the details of a 1031. A couple problems dividing a property and selling in a “Timely” manner and then picking exchange properties of equal or greater value than the lots you sale. Basically impossible with that many lots. Let’s say you have 12 lots and if everything went perfect in the exchange you would recognize your $30,000 profit per lot across the board. But let’s say you sold 3 within the 1031 timeframe and you also found a property or 2 or 3 that are equal to or above your basis. You would think you would also recognize the same $30,000 per lot profit? Talk with an Accommodator. If you go forward also ask them about doing a reverse 1031. You have more control over the timing.

Basit Siddiqi · Answer

You may want to pay an appraiser to determine the value at the time of inheritence.