Q: My siblings and I recently inherited some apartment buildings in Orange County.
I understand that if we keep the buildings, we can keep the current property tax bill as well. We are considering a like-kind exchange for apartments in another city in Orange County. Is there any way to carry over our 1960’s tax amount?
A: Potentially you are asking two different questions regarding taxes. One question may have to do with real estate taxes and the other with the amount of taxes you would have to pay upon the sale of your real estate.
A like-kind exchange is a mechanism used by investors in real estate (and also with other types of property) that allows the investor to defer the payment of federal income taxes. It is also known as a 1031 tax-free exchange.
Simplistically, if you purchased a property 10 years ago for $100,000 and now it’s worth $1,000,000, you would potentially have to pay taxes on the appreciation and would have to pay taxes on any tax benefits you received on the depreciation you took on the property while you owned it.
A like-kind exchange would allow you to sell the $1,000,000 property and replace it with one or more replacement properties. The total value of the replacement property or multiple properties would have to exceed $1,000,000. In addition, you would have to hire an exchange company to assist you in the transaction (also known as a qualified intermediary) and would have to comply with certain timing rules relating to when you would have to find a replacement property and close on the purchase of the replacement property.
In general, once you sell your current property, you have 45 days from the date of the sale to designate a replacement property and 180 days from the date of the sale to close on the purchase of the replacement property. While there are limits to these rules, you will need to work closely with an attorney who has ample knowledge of like kind exchanges and work closely with your exchange company (qualified intermediary).
If you recently inherited the properties, the cost basis for the properties would be their value at the time the owner of the properties died. If you turn around and sell them a short time after inheriting them, you may not owe any federal income or capital gains taxes on the properties.
If you have no federal income taxes to pay, you may also have no state income taxes to pay and you might not need to use a like-kind exchange to achieve your financial goals.
You should talk to a knowledgeable accountant for further information about the specifics of what you’re trying to do.
Now let’s turn to your real estate tax question: You should contact the Orange County Assessor’s or tax collector’s office to discuss whether they allow the real estate tax basis from the sale of a property within the county to be transferred to another property within the county.
Most taxing authorities that allow a freeze or incremental increases in the valuation of real estate are eager to have the property sold or transferred to allow them to bring the property’s value up to the current rates. For primary residences, or for seniors of a certain age, some local municipalities may allow a break in taxes when a person moves within the municipality but it’s less likely for investment and commercial properties.
If you have additional questions, talk to a real estate tax specialist in your area.
January 29, 2008