Cedric settled on the property, the money went to the qualified intermediary and 45 days later he found a great piece of vacant land to invest in. He settled pretty quickly, the intermediary wiring the money smoothly, and he deferred the taxes until he sells this land. He was thrilled. Feeling rich, he went by the Biker’s shop and bought a new Crotch Rocket. Two days later, he died in a a motorcycle accident. His family got to step up his basis in the property (as is allowed after a loved one dies) to the date of death value, and they quickly sold the land and paid no income taxes on the transaction.
Author Archives: John
Have a great Sunday
Today, I’m planning on attending a children’s Christmas pagent. Nothing says Christmas like small children singing carols and songs. Have a great day and we’ll resume tomorrow to see what happened to Cedric.
The Plan
“Hi, I’m Cedric”. “I’m Ito Brassballs, what can I do for you?” “I’ve got this condo that I’m selling and I’m supposed to make about $475,000 in gains, and I heard that there’s something called a like kind exchange that can save me some taxes”, Cedric said matter of factly. “Is it an investment property?” the lawyer queried. “Yes”, Cedric answered. “Then, yes you can do an exchange for other real property. There are two types of like kind exchanges. A direct exchange which happens rarely these days because it so hard to match two people to swap property. The other is a deferred exchange in which you settle on the property, the money is placed in the hands of an intermediary and held in an escrow account. You have 45 days to identify replacement property and 180 days to settle on it, under the safe harbor under the regs”, Ito answered. “So let me get this straight, I settle on the property, go out and find new property, identify it to the Intermediary in 45 days, settle on it in 180 days?” Cedric repeated. “Yes”, there are a few other rules. The replacement property must not be purchased for personal use. You have to take on as much debt as you had on your previous property or recognize gain. In essence the purchase price has to exceed the purchase price of the property you’re surrendering”, as a rough rule of thumb. Also, if you get any cash you’ll owe tax on it. Your basis will only change slightly so you ae deferring the taxes not saving them. I can prepare an addendum to your sales contract”, Ito replied. “That would be great “ Cedric replied. After Ito told him all the fees involved, he prepared the addendum to the real estate sales contract.
I’ll trade you a condo for a farm
We are now embarking on a short tale about the concept of like kind exchanges. The Tax Code permits the tax free exchange of property of like kind so long as no cash or non-like kind property changes hands. We will start with the easy tale of the pure unvarnished like kind exchange and move to tales involving more complex portions of the law.
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Cedric bought a condo for rental in 1990 for $200,000. As required by law, he took depreciation (whether he wanted to or not) from 1990-2009 in the amount of $125,000. In 2009, out of the blue he was offered $500,000 for the condo. He consulted his accountant, Frank Dinero.
“Cedric, you’ve got a gain of $425,000 which means that your state and federal taxes on the sale will be $85,000.” Cedric left saddened and went to Tough Times Bar to drown his sorrows. As he was having his fifth beer, a biker sat down beside him. “You look low man”, the biker said. “Yeah, I guess I shouldn’t be upset, but I learned that in selling a condo I bought for investment that I’m going to owe a lot of taxes”. The biker frowned for a second and said, “what are you going to do with the money?” That question caught Cedric a bit off guard and caused him to be suspicious. “Why are you askin?” Cedric responded. “Whoa man, just thought if you was going to invest in other real estate you could defer some taxes”, the biker said raising his open hands. “What?” Cedric replied.
“I was sellin my garage to another dude because I needed a bigger one for my custom bike business. My lawyer put me onto this trick called a Like Kind Exchange. And I rolled all my gain into my new building and paid zero taxes.” “Really?” Cedric asked. “I’m not shittin’ ya man?” said the Biker. “Thanks”, Cedric said, “what are you drinking, I’m buying”, Cedric continued, “Bartender give this guy whatever he wants to drink”.
The next day Cedric called his lawyer, “Have you ever heard of a like kind exchange?” “Yeah, but you should talk to a tax lawyer about that, one of my partners here a Mr. Ito Brassballs can help you.” Cedric made an appointment with Ito.
In Today’s Washington Post, there is an editorial asking for the fix to be put into place for the Estate Tax.
My view is that first and foremost, Congress needs to deal with the one year repeal of the estate tax. That is not only unworkable, but can lead to the bizarre situations set up over the past few months on this blog. I also believe that the estate tax needs to be either eliminated or overhauled. Why? First, by creating the unified credit on a per individual basis as opposed to a couple basis, it creates a need for unnatural planning. Second, it discriminates against non-citizen spouses (who do not get a marital deduction for what they inherit). Third, it discriminates against unmarried people and their significant others. The estate tax itself is also discriminatory. It discriminates against people who save. It discriminates against entrepreneurs and innovators. It discriminates against farmers (who are land rich and cash poor). My view is that the tax ought to be repealed completely. But understanding that government needs money to pay the bills and dead people don’t squawk as much as the living, I can live with an estate tax. The fix ought to be this. First, the rate. The rate ought to be the same as the capital gains rate because all other assets have already been taxed. This seems to be the fairest method of dealing with this. Second, there should be an exemption of $10 Million per couple and $5 Million per individual. This reduces the number of estates filing to a fraction. The exemption should be indexed to the inflation rate for real estate nationwide (this helps farmers to some degree and small businesses which own real property). The underlying issue and one that is one of philosophy is that of “inherited wealth”. Our Founding Fathers abhorred royalty. Concentrations of wealth create an economic royalty which can lead to a political royalty. After all, kings and lords owned lands which they rented to serfs who worked the land and turned over the profits to the Kings and Lords through duties. An estate tax in essence redistributes that wealth, but not to the people, but to the Government which increases its power and size. The Founding Fathers also abhorred a strong central government. So, with an estate tax you have two competing issues one of concentration of wealth (which is bad) and bigger Government which is also bad. The Government is ill served to play the role of Robin Hood and so which is the greater evil. Inherited wealth or big government. Inherited wealth can be toxic, but to grow it has to invest or it gets consumed. Increased Government hurts growth due to the need for it to micromanage everything. I have no problem with taxes being levied to pay for necessary Government functions, but I do have problems when Government uses the tax code to change behavior. The estate tax is one such area abused in this way. If you need an estate tax to pay for the essentials of Government, then by all means levy one. But don’t enact one to punish the rich, or to redistribute wealth or to grow government. That is not what taxes are for.