- Closing Adjustments: Sellers get repaid at the closing for all of their prepaid service contracts and supplies that they transfer to the purchasers. To do this, sellers identify each contract that they have prepaid for the carrying costs of their home. Next, sellers create a per diem cost allocation for each particular contract and multiply that cost by the days remaining on the contract on the closing date.
Examples of contracts that sellers locate for adjustment purposes include:
- Fuel contracts such as propane and oil
- Water contracts
- Real estate town and village taxes
- Condominium / cooperative common / maintenance charges
- Pool service contracts
- Tick and mosquito control contracts
- Gardening contracts
- Pest control contracts
Many also require the seller to order timely meter readings to determine the amount of the product, such as oil, that remains in the tank on the date of the closing. When all is said and done, a savvy seller recoups tens of thousands of dollars in prepayments if everything is documented and adjusted.
Yet, 1031 rules are quite cumbersome and have requirements for:
- Deadlines to identify property
- The means of identifying a property
- The number of properties that can be identified
- The price of such property
Those with vacation homes also consider a 1031 exchange as the Internal Revenue Service offers a safe harbor to qualify such homes through rules embodied in Revenue Procedure 2008-16 regardless that such vacation homes were residences at some point in their history. A 1031 exchange enables a seller to generate income on future properties through compounding pre-tax dollars. Albert Einstein described this type of compounding effect with money as "the eighth wonder of the world."
To illustrate this savings, while IRC §121 saves a maximum of 157,500 on a maximum gain of 500,000, there is no like maximum cap on a step-up-in-basis and every dollar of gain on top of the first 500,000 can receive a like savings.
So, assuming the real estate was purchased originally at 50,000 and it is now worth 4,000,000, and further assuming the decedent was in the highest possible tax bracket right before death, the family will save 1,260,000 in taxes by selling post-death.
Adapted from this Dan's Papers post.