Will we need to 1031 this to avoid capital gains?

Question

Located in Texas. Scenario as follows - Husband buys rental property decades ago. He passed away about a year ago. Wife is selling property now and stands to make somewhere near 500K on it in profit. Does this follow the step up basis or death tax exemption? Or will she being paying long term capital gains on the profit?

Nicholas Dutson · Answer

@Jacob Bremer Texas is not “common law” for property ownership between spouses. Texas is a community property state. That matters a lot here.

1) “Only in his name” does not automatically mean no step up or no community property

Even if the deed was only in his name, the property can still be community property depending on when and how it was acquired (during marriage with community funds, for example). Title and ownership are not always the same thing in Texas.

2) Step up basis is still the starting point

Because he died, the basis is generally stepped up to fair market value at date of death:

• If it was his separate property (owned 100% by him): When she inherits it, the basis for her is typically stepped up on that interest.
• If it was community property: Texas often allows a full step up on both halves of community property at the first spouse’s death, even if only one spouse was on title, as long as it was actually community.

If it was his separate property (owned 100% by him): When she inherits it, the basis for her is typically stepped up on that interest.

If it was community property: Texas often allows a full step up on both halves of community property at the first spouse’s death, even if only one spouse was on title, as long as it was actually community.

Either way, if she sells close to the date of death value, the taxable gain is often much smaller than people expect.

3) If she wants to buy another property, can she 1031?

Yes, but only if the seller and buyer in the exchange are the same taxpayer.

In practice that means:

• She must be the owner of the relinquished property when it sells (or the estate must be the exchanger if the estate is selling it before distribution).
• The 1031 has to be set up before closing with a qualified intermediary. You cannot “decide after” and fix it.

She must be the owner of the relinquished property when it sells (or the estate must be the exchanger if the estate is selling it before distribution).

The 1031 has to be set up before closing with a qualified intermediary. You cannot “decide after” and fix it.

Also, if the basis was stepped up, she might not “need” a 1031 to avoid a big gain, but a 1031 can still help if:

• The property has appreciated meaningfully since date of death
• She has taken depreciation after inheriting it and wants to defer depreciation recapture
• She simply wants to keep rolling into other investment property without recognizing current gain
• 4) Quick action steps I would take

The property has appreciated meaningfully since date of death

She has taken depreciation after inheriting it and wants to defer depreciation recapture

She simply wants to keep rolling into other investment property without recognizing current gain

4) Quick action steps I would take

• Have an estate attorney or CPA confirm whether it was community or separate under Texas rules (facts matter).
• Get a solid date of death value (an appraisal is best).
• Confirm who will be the seller at closing (estate vs widow) because that controls who can do the exchange.
• If she is exchanging, get the QI lined up early and make sure the contract language and closing flow support a 1031.

Have an estate attorney or CPA confirm whether it was community or separate under Texas rules (facts matter).

Get a solid date of death value (an appraisal is best).

Confirm who will be the seller at closing (estate vs widow) because that controls who can do the exchange.

If she is exchanging, get the QI lined up early and make sure the contract language and closing flow support a 1031.

If you tell me whether he bought it before marriage or during marriage, and whether there was a will or it is going through probate, I can point to the most likely path and the common pitfalls.

Nicholas Dutson · Answer

@Bill B. Not unique to real estate. Community property is a state law concept, and when an asset is community property, federal basis rules often allow a full step up at first death. Minnesota is not community property, so you usually only see a step up on the decedent’s share. Nevada’s no state income tax helps, but federal capital gains can still apply to post death appreciation or depreciation.

Aaron Zimmerman · Answer

do you know the approximate fmv at date of death? You would get a step up in basis but you'd need to know fmv at date of death.

let's say the property was purchased for $200k and appreciated to $1,000,000 and the property is owned by person a. Person a dies and passes it onto Their heir, person b. Person b's basis is $1M. Person B sells the asset for $1.1M 1 year later. Person B has a 100k gain on the sale.

Bill B. · Answer

@Jacob Bremer  Especially since you can deduct the selling costs. So unless it appreciated significantly more than the closing costs she’s good.

@Nicholas Dutson is Texas being a community property state only on real estate unique? My father passed in MN and I’m sure when I looked she would only get 1/2 stepped up.

Looks like another advantage of Nevada not having income tax and being community property state.  My wife can sell everything tax free when I die. :-)

Mike Krieg · Answer

Not much appreciate over the last year so value is there. 1031's are much harder to pull off than they say.

Jacob Bremer · Answer

It was less than a year ago, so the FMV is about the same, maybe less actually, but very close. So it'll be a wash from a year ago. I just wanted to make sure they werent paying from when they purchased decades ago. From the sounds of it, a 1031 in not really needed since there is no capital gains.

Jacob Bremer · Answer

She wants to buy another property. I wouldn't asked about a 1031 if she didn't. It's not in an LLC or jointly, just his name, but Texas is common law.

Greg Scott · Answer

Realistically, you need to know her entire financial picture to assess the impact.  You did not mention it, but another key factor is knowing how the property was titled.  Was it in just his name, held jointly, an LLC?

And, unless she wants to buy another property, which I suspect she wouldn't, a 1031 is not feasible.

Will we need to 1031 this to avoid capital gains?

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