USING 1031 EXCHANGES TO
TRANSFER WEALTH TAX FREE
By Gary Gorman, Manager
Professional Exchange
Accommodators, L.L.C.
A 1031 exchange is a technique that investors commonly use to transfer property tax free. However, our sophisticated investors are using 1031 exchanges to transfer large amounts of wealth, tax-free to their children. This is how it works: Mom and Dad own a building that is worth $100,000 and is free and clear. Finding a new building worth $150,000, they sell their old building and use a 1031 exchange to buy an undivided 2/3’s interest in the new building for cash. Their children buy the other undivided 1/3 interest. A year or two later they sell the building for $250,000, of which $166,667 is the parents 2/3’s share with the balance of $83,333 belonging to the children. Both the parents and the children do 1031 exchanges and buy a new property for $400,000 of which $166,667 (or 42%) is the parents, and the balance of $233,333 (or 58%) belongs to the children. If this building is then sold for $500,000 and a new building is purchased for $600,000, the parents 42% share of the sale of the old building ($210,000) would be transferred tax free to the new building, resulting in a 35% share with the children’s share now 65% and worth $390,000. If the parents are in the upper Federal estate tax bracket of 55%, their estate tax savings would be at least $214,500, and probably much more depending on the estate taxes payable to the state that they live in. Depending on the cash flow needs of the parents and the kids, there is ample opportunity to direct the cash flow from the properties over the years using “management fees.” Another technique that we at Professional Exchange Accommodators have used to assist clients in transferring wealth is to have the parents buy individual replacement properties, with the intent to transfer the property to the children upon the parent’s death. To illustrate, assume that elderly parents sell bare land for $900,000. They have three adult children and plan to leave their estate equally to the kids. If they sell the land outright, State and Federal income taxes on the gain will probably eat up about 1/3 since their basis in the land is almost nothing. As an alternative, they could do a 1031 exchange, sell the land, and buy three commercial buildings for $300,000 each as the replacement property—one for each of the kids. Since the intent is that the kids will inherit the property, each of the children could be actively involved in the purchase on one of the properties, with the intent that that kid would inherit that property. For example, if one of the children is a high income doctor, they may choose bare land for their investment in order to avoid further taxable income. The low-income teacher child, meanwhile, may choose a property with a high level of income and cash flow. An added benefit to the parents in this situation is that their income would certainly increase since they are moving their investment from bare land to income producing commercial property. And, if any of their children need help with money while the parents are alive, they could pay them a management fee to care for that child’s property. This would be tax deductible to the parents.This is just two examples how our clients have used 1031 exchanges to transfer wealth to their heirs. While there are many more, time and a good plan will obviously let you move a great amount of wealth to your heirs using simple 1031 exchange techniques. As always, when you have a complicated exchange transaction, a knowledgeable exchange professional is key. Gary Gorman is the manager and co-owner of Professional Exchange Accommodators, LLC. He has 25 years of experience as a Certified Public Accountant where he spent much of his career in what was then Big 8 accounting and retired as a Tax Manager with Price Waterhouse & Co. Gary now spends all of his time handling 1031 exchanges for his clients and is a frequent writer and lecturer on 1031 issues. Professional Exchange Accommodators is one of the nation’s largest Qualified Intermediary firms and handles approximately 8,000 straight exchanges and 350 reverse exchanges a year and has Florida offices in Naples and Tampa..
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