Inheriting Commercial Real Estate

What should you do when you are inheriting commercial real estate and you have decided that you don't want to keep it long term? First, be aware that commercial real estate, just like a residential real estate inheritance is potentially subject to capital gains tax if you retain the commercial real estate long enough for it to have appreciated in value since the death of the previous owner.

This is an important concept to understand, because you will be potentially liable for capital gains only on the appreciation that occurred since the date of death. As an example, if you inherited a piece of commercial real estate that your father bought for $400,000 in 1980 and when he died in 2007 it was worth $1.3 million and today when you want to sell its worth is $1.4 million you would only pay taxes on difference in its value from when your father died to the date you sell it.

You do have an option to defer capital gains taxes when it comes to inheriting commercial real estate and then selling it. This capital gains tax deferral option is called a "like kind exchange" or a 1031 exchange. This is a completely legal way for you to sell commercial property that you may have inherited and transfer all of the profits into another, similar commercial property thus deferring the capital gains tax.

If you decide to sell commercial property using a 1031 exchange, there are very strict rules that must be followed. The sales contract that is used to sell your inherited commercial property has to contain specific language that identifies the sale as being part of a 1031 exchange and youwill have to work with a specialfirm called a "Qualified Intermediary" to actually handle the proceeds of the first sale and supply the funds for the purchase of the replacement property. You are not allowed to actually receive any of the profits from the sale directly; if you do then those funds are subject to capital gains tax.

You will have up to exactly 45 calendar days to identify replacement properties after your current property closes, and then you have up to exactly 180 calendar days from the date of your sale to close on the replacement property. For the best results assemble a team with 1031 expertise to help you including a commercial real estate broker, your tax advisor and a qualified intermediary.