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1031 exchanges involving appreciated land

Many New York farms have been owned by the same family for generations. With property values rising, some owners might be looking to cash out but are concerned about the capital gains tax they might have to pay on the appreciation. There is a provision in the Internal Revenue Code, however, that might allow them to defer that tax at least temporarily if the sale transaction is properly structured.

Under Section 1031, taxpayers can defer the recognition of a capital gain if a piece of property is exchanged for another property of like kind. This can happen simultaneously, or it can be deferred if structured properly as part of the same transaction. The acquired property does not have to be identical. In this example, most real estate that will held for business or investment purposes will qualify as "like kind". This can enable a seller to earn a higher rate of return than that being produced by a farm.

The tax basis of the acquired property will be the same as the basis of the property that was relinquished. Accordingly, any unrealized appreciation on the original property will be recaptured when the new property is eventually sold. However, there is a way to get around this. When a person dies, the tax basis of property owned by the decedent is stepped up to the fair market value on the date of death. Accordingly, an heir who receives a piece of appreciated property will only have a tax liability on any appreciation that occurs after such date.

This shows that the tax aspects of estate planning can involve more than just federal estate and gift taxes. Owners of appreciated property who are considering bequeathing it to their heirs may want to meet with an attorney to see if this type of transaction would be appropriate for their circumstances.

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