Affect of capital gains tax on Starker exchange deferred tax

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10 years ago I purchased a house through Starker exchange and then rented the property. This continued for 3 years and after that, it is lying vacant? I have been staying there for 2 months every year during summer. We now plan to give away our house to our heirs after our death. now, if my heirs sell the property after they inherit it, how will capital gains tax which I have deferred through the exchange affect the sale?

Samantha

Hi Mary,

Welcome to the forums.

You need to know about the tax implications of 1031 or Starker Exchange.

Let's take an example: Suppose in 1996, you have bought a property worth $60,000. This is the relinquished property. In 2001, when the property was worth $120,000, you exchanged it for the current property or the replacement property, which was valued at $120,000. At present, the replacement property is worth $400,000.

Now, since the replacement property was worth $120,000 when you bought it, because it was obtained through starker exchange, the tax basis remains the same, that is, the cost of the relinquished property or $60,000.

If the current property is sold for $400,000, you will make a profit of $340,000 ($400, 000 – $60,000) although you have paid $120,000 to buy it. Your capital gains taxes will be calculated on $340,000 at the current tax bracket fixed by the IRS.

Now, on your death, your heirs will have to pay capital gains tax on a stepped up basis. This implies that if the property value on the date of your death is $500,000, it will be taken as the new basis for calculating capital gains tax. For example, if the property is worth $500,000 on the day you pass away, and your heirs sell it at a higher price, they shall have to pay capital gains. Otherwise, if they sell at the same price as the value of the property, no capital gains tax need to be paid.

Thus, even if you can defer taxes on account of Starker exchange, you may still have to pay capital gains tax.

Hope this is clear to you.

God bless you.

Samantha

helping_user

Hi Mary,

Starker Exchange is possible only in case of investment property. The Internal Revenue Service states that anyone using his property as investment for at least 2 years can get tax deferred benefits through the Starker exchange. But your replacement property is not an investment property as you are using it personally. However, you have rent it out for at least the first 3 years, which is a kind of investment. So, tax deferred benefits through the Starker exchange is applicable in your case.

Thanks

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