Two of us want to take the money, and the other person wants to do a 1031 exchange. Are the three of us in agreement on this part? Also, how do we calculate any capital gains tax we may owe? We were offered $2 million for the property.

A: Have you consulted five professionals and still haven’t received the answer you were looking for? Alright, let’s give it a shot.

Let’s start with what happens when you inherit property. As we have explained in previous columns, when you inherited this property, you received it at its market value on the date of your father’s death. So even though he bought it for $100,000, if it was worth $2 million when he died, that’s the gross-up basis for tax purposes.

But did he die a year ago or 30 years ago? Is the property fully depreciated? The answers to these questions have a direct impact on the tax you will have to pay. We’ll get to those questions in a moment.

A 1031 exchange is a mechanism used by real estate investors to defer federal income and capital gains tax when selling investment real estate. Essentially, you are buying a replacement property that costs the same or more than the property you are selling on a very tight deadline. The name comes from Section 1031 of the Internal Revenue Code. We wrote about the general rules of scholarships 1031 over the years.

In your case, the LLC could sell the property and would then have to purchase a replacement property that costs at least $2 million to defer federal income tax on the sale of the investment property.

But here’s the catch: two of you want to keep the money generated from the sale, and one wants to defer the taxes owed.

If the LLC sells the property, the LLC is the only entity that can undertake the 1031 exchange. In this situation, it would be all or nothing for the company. That said, the LLC can distribute the property before the sale to the members and each member could then sell their interest in the property to that buyer.

Let’s say each of you owns one-third of the business and each of you has passed on the one-third interest to the buyer. A sibling could sell their interest to the buyer, set up a 1031 exchange broker, and follow the 1031 rules to buy a replacement property. This sibling should be able to defer federal income and capital gains taxes through the use of a 1031 exchange, and the other two siblings would simply sell their share of the property and pay the taxes they owe to the federal government.

Be sure to speak to a 1031 exchange expert to explain the mechanism you will need to follow to distribute the interest in the LLC’s ownership to its members.

How much would you pay in taxes? You haven’t given us enough information for us to make a rough calculation. Suffice it to say that you and your siblings inherited the property at the value it was at the time of your father’s death.

But here’s how to think about it: Start with the date your father died. If the property was worth $1.5 million at the time of his death and you sold it for $2 million, it would be easy to say that you owe tax on the difference, which is $500,000. But this is an investment property, and we don’t know if you and your siblings have put money into the property (or how much), how long you’ve owned the property, and how much depreciation you took during the period you owned the property. goods.

If you inherited the property 30 years ago and have now fully depreciated the property, you may have to pay significant tax for the recovery of depreciation (at a rate of 25% of the depreciated amount) and for capital gains. For answers to these questions, you will need to speak to one of the accountants, preferably one with extensive knowledge in the area of ​​federal real estate taxation, depreciation and capital gains.

We also suggest you talk to someone who works at a tax-deferred exchange company that specializes in 1031 exchanges. However, you should talk to someone who has been doing this for many years because your situation is complicated and if get it wrong, you could break the many rules that govern 1031 exchanges and end up with a huge tax bill, complete with penalties.

Ultimately, we think it’s possible to split ownership and then allow two of the siblings to pay the taxes owed and pocket the remaining money while the third reinvests his share of the proceeds. But once everyone has seen how much tax they will have to pay, everyone may be more interested in reinvesting that proceeds into a structured real estate investment to generate long-term income.