Passing Away While Owning Real Estate

I want to talk about, it’s not a fun topic. I want to talk about death. I want to talk about how tax code applies to us. Going back to being a real estate investor, I want to talk about the consequences that occur as far as we own real estate investments and we pass away. What happens with that, number one? Assuming that we have an estate plan in place. As far as from a taxation stand point, what happens when we pass and our heirs get our property? As far as taxation’s concerned?

Okay. We get what we call step up in basis if it’s done correctly. Let’s kind of talk about that. You own, let’s just say you own a building that your basis in that building, it’s been depreciated and maybe the basis is fifty thousand dollars on that holding. It’s worth five hundred thousand dollars today. If you own that inside of your LLC when you die, that building gets a step up in basis to the value of today, which is five hundred thousand. Your heirs sell it tomorrow and they basically have no tax.

Hmmm.

The problem we see a lot is where people have those pieces of property and they have them inside of corporations. The problem when it’s inside of a corporation is typically the real estate doesn’t get a step up in basis, the corporation gets a step up in basis.

Ahhh

Very rarely do you want to buy somebodies corporation. You want to buy their assets. If you buy their corporation, you could be on the hook for some future liabilities. If they sell the asset inside, they don’t get a step up in basis. Now they have this whole tax ramification that they wouldn’t have if it was done properly. Which took a little bit of planning.

Interesting.

That’s a mistake we see very often. Very often.

Do people even use, now days is it common to see real estate investors use C Corps? As their entity of choice? I feel like that’s two or three decades ago common. Before LLCs became a lot more popular.

C Corps are rare, but we see them. S Corps are not that rare.

Yeah. Okay.

You don’t get the step up in the S Corp.

I don’t want to fall off the deep end here, but what would be one of the reasons why someone would form an S Corp versus an LLC? I’m talking strictly from a real estate investment perspective.

I would pretty much say no planning was involved. Sometimes they form them themselves. Sometimes they don’t really have a real conversation with the attorney, you know.

Gotcha. So not many reasons why.

It’s usually not a good reason. Every once in a while. If it’s foreign owned, then there’s difference.

Sure.

For the most part there’s usually not a good reason.

Okay. Okay. I know we’re kind of all over the board here. There’s so many topics where we can go. There’s a lot I want to cover here in the short time we have together. As far as 1031 exchanges are concerned, I think most everybody probably knows what a 1031 tax deferred exchange, is that something that your firm advises on as well? I know that you guys aren’t probably an intermediary. Is that something that you have a lot of knowledge in?

We’ve been involved in a whole lot of them over the last, I’d say, probably 15 years. Yeah. Sometimes we see they’re accounted for incorrectly, too. A big mistake you see with 1031’s is they start the 1031 in October. 1031 fails in March, then they wind up picking it up in October on their income tax return. They probably didn’t make estimated payments and they get these big penalties.

Retroactive.

When really it should have been picked up in the following year. It could be, penalties, we had one where it was a big sale. Wound up having it go back and amend it. It saved them quite a lot of money in penalties.

So there’s a way to set up the 1031 to where if it’s carrying over to the following year, there’s a way to set it up so that it doesn’t become retroactive? To the prior…

Right. If it’s done correctly, it flows and it’s failed, it flows into the taxes of the following year not the preceding year.

Gotcha. Gotcha.

Remember you don’t have access to that money.

Yeah. Yeah. What are some other things that we need to know? I want you to put yourself in the shoes of you’re giving, you’ve got 10 minutes, or 15 minutes to give anything we haven’t covered so far. You’re in a room full of fairly new real estate investors. Maybe a few that are somewhat seasoned, but fairly new. What other advice would you give in a short period of time that you feel is incredibly relevant and important to know? Assuming that we can. We only have 10 or 15 minutes left to chat.

Okay. The most important thing is to communicate with your professionals. If you’re in this business, you should have team of professionals. You should have your attorney. You should have your advisor. You should have your CPA. They should be part of your team. You should be communicating with that team. All right. They’re there, use them. Get the value out of them.

Some other things that from a planning perspective is if you own real estate you can have companies that manage your real estate. You can hire your kids inside of those companies to manage your real estate. The first six thousand dollars is not taxable. If you do it correctly, you have to document everything. Tax court says you can hire your kid as early as age seven. We typically don’t recommend that. I like to see 11 and 12 year olds or older. Let’s just say the kid goes to a private school in Florida. You can make that private school tax deductible. You pay your child. The money goes into his bank account. Then the draft, the monthly draft for his school comes out of his account. You’ve made a non-deductible expense a deductible expense.

Interesting.

Another thing is missing medical benefits. People with large out of pocket, whether it’s braces, or older people when they have a lot of cosmetic stuff done can set up a medical expense reimbursement plan. Now all of a sudden you can send that 10 or 15 thousand dollar medical expense that you really would not get the benefit of, and make it 100% deductible.

Interesting. Okay. I didn’t know that either. I’m learning all kinds of new stuff.

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