Dog plays major role in establishing residency
Differences in state tax rates create incentives to move to low-tax jurisdictions, or to at least claim to have moved. States spend considerable time and resources trying to fight claimed moves that are unsupported by the facts.
When someone claims to be a resident of a low-tax state, but a high-tax state thinks it has rights to that person’s income, a “factor” analysis is often used to try to sort out the actual state of residency. I just read about such a case that used a factor I had never heard of before — the residency of the taxpayer’s dog.
Gregory Blatt was a resident of New York. New York has a high state tax rate, and New York City also has an income tax. Blatt then became CEO of Match.com, which is based in Dallas. Texas has no income tax.
Blatt kept a New York apartment but also signed a lease for a Dallas apartment. His employment contract said he would be based in Dallas.
Using a factor analysis, New York officials claimed Mr. Blatt’s income still belonged to them, and they assessed $430,065 in taxes. The New York Division of Tax Appeals had to determine Mr. Blatt’s residency.
While many factors were analyzed, the fact that Mr. Blatt’s dog moved to Texas was considered to be important in finding that he had changed his residency to Dallas. The court said the location of items “near and dear” are important in establishing residency.
Q: My husband and I sold a building we have owned for 16 years in December 2016. The sales price was $2.2 million. Our accountant says the tax basis is $740,000, so we used a company to facilitate a 1031 exchange. By purchasing replacement property, we can defer the tax on this large gain. My husband passed away in February. In January, we identified two possible replacement properties and I have a purchase agreement for one that will close in April. My question is whether I can defer the entire gain on the December sale by completing the exchange for both myself and my husband. My accountant is not sure.
A. You can do better than defer the gain. You will be able to completely avoid the gain, provided you complete the exchange and the replacement property covers the full amount of the December sale.
Ignoring closing costs, your realized gain from the December sale is $1.4 million. This can be deferred by completing a Section 1031 exchange. For example, if $2.2 million of replacement property is acquired, the tax basis of that property will be $740,000 but no gain will be recognized.
Your husband’s death makes it impossible for him to complete his half of the exchange. However, you (or his estate, depending on who acquires his rights) can complete it on his behalf.
Completing the exchange for both you and your husband would generally mean no recognized gain, but the $740,000 tax basis for the replacement property would simply defer the gain until that property was sold.
One of the assets that your husband owned at death was the right to his share of the replacement. This right, valued at $1.1 million, would be included in his gross estate for tax purposes.
The tax law allows someone who inherits property to adjust the tax basis of that property to its value at the date of the decedent’s death. If the property is community property under state law, the law upgrades this into a basis adjustment for both halves of the community.
If the exchange is completed, your husband’s rights in the property are subject to the date-
of-death basis adjustment. If the asset relinquished was community property, you also get that same basis adjustment for your half of the community.
So if the exchange is completed, your basis in the replacement property will be its purchase cost. All of the $1.4 million gain is eliminated by this adjustment caused by your husband’s death.
If the exchange is not completed, no adjustment is allowed because the December sale created what the tax law calls “income in respect of a decedent.” But the IRS has held in Letter Ruling 9829025 that the community basis adjustment is allowed if the exchange is completed.