How to Plan for Taxes When Transferring Commercial Real Estate to Your Heirs

When it comes to transferring commercial real estate to your heirs, the tax implications can be significant. Due to this significance, it is important to plan right which tends to be quite complex. Commercial property is one of the most valuable things you can leave so the planning is crucial. At Whittaker we help people preserve their family wealth all the time and these are some things we have learned.

1. Understand the Federal Estate Tax

The federal estate tax applies to estates valued above a certain exemption amount. For 2024, this exemption is set at $13.61 million per individual. If the combined value of your estate exceeds this amount, the excess could be taxed up to 40%.

By knowing where you stand in relation to the exemption threshold, you can better plan your estate to minimize tax liability. High-net-worth individuals may benefit from strategic tax planning, such as gifting during their lifetime or establishing trusts to control the timing and distribution of assets. Setting up a trust is a must if you are wanting to pass anything with a significant value on.

2. Understand Depreciation Recapture

Depreciation recapture refers to the process by which the IRS taxes the gain from the sale of an asset that was previously depreciated. When you own commercial real estate, you can deduct a portion of its value each year as depreciation. This effectively reduces your taxable income. However, when the property is sold, the IRS requires you to “recapture” these deductions. This is done by taxing them as ordinary income, up to a certain limit, depending on the property’s sale price.

How Depreciation Recapture Works

For example, if you purchased a commercial property for $1 million and claimed $200,000 in depreciation over the years, the adjusted tax basis of the property would be $800,000. If you sell the property for $1.2 million, the IRS will apply depreciation recapture taxes to the $200,000 in depreciation previously claimed.

Depreciation Recapture When Passing on Commercial Real Estate

When transferring commercial real estate to heirs, depreciation recapture rules differ based on whether the property is inherited or gifted:

  1. Inherited Property:
    • Heirs benefit from a stepped-up basis, which adjusts the property’s tax basis to its fair market value at the time of the original owner’s passing.
    • Because of this adjustment, depreciation recapture is typically avoided when the property is inherited. If the heirs sell the property immediately or shortly after inheriting it, they would only pay capital gains tax on any appreciation beyond the stepped-up value.
  2. Gifted Property:
    • If commercial real estate is gifted during the original owner’s lifetime, the recipient (heir) retains the original owner’s tax basis, including all depreciation deductions taken.
    • If the heir sells the property, they may be liable for depreciation recapture taxes based on the deductions claimed by the original owner, which can lead to a significant tax liability.

Key Considerations for Estate Planning

  • To minimize the impact of depreciation recapture, it’s generally more tax-efficient to transfer commercial real estate through inheritance rather than gifting.
  • If depreciation recapture is a concern, strategies like placing the property in a trust or structuring the transfer through other estate planning tools can help mitigate the tax burden.

5. Consider a Trust for Seamless Transfer

Establishing a trust can offer tax advantages and added flexibility for transferring real estate. Trusts can be designed to help bypass probate, offer privacy, and potentially reduce estate taxes. By placing the property in a trust, you can control the timing and manner of asset distribution. This way you can ensure your property aligns with your wishes and minimizes potential taxes.

Final Thoughts: Work with a CPA to Protect Your Family’s Wealth

The tax laws around estate planning are complex and ever-evolving. Partnering with a CPA can help you develop a personalized strategy that aligns with your long-term goals. At Whittaker, we’re here to guide you through each step of estate planning for your commercial real estate. We love helping ensure a seamless transfer to your heirs with minimized tax exposure.

Want to learn more about estate tax planning for high-value properties? Contact us to discuss how we can help you plan for the future and protect your legacy.