1. 24961 The Old Rd, 2 nd Floor Stevenson Ranch, Ca 91381 Ronald D. Morgan, CPA Ron@sksm.com Tel: (661)286-1040 Fax: (661)286-1050 TOOLS for SUCCESS C-REX.org June 14, 2007

2. Why does it matter how real estate is owned? First, let’s look at a married couple: John H. purchased his home in 1987 for $150,000. In 1995, John married Paris and they bought a new home together for $300,000, and rented out his old home. In 2007, John died. Let’s assume the rental home was worth $1,000,000, and their residence was worth $1,500,000. This presentation will be solely concerned with income tax effects.

3. First Situation: First Situation: John did not change his vesting title on his rental property when he got married, but they used the rent money to enrich their joint lifestyle. When he and Paris bought their new home, they bought their new home, they held it as “Joint Tenants”. So, it appears that John “co-mingled” his rental income, thus making the property a community asset.

4. Upon someone’s death, most of their assets get a new income tax basis. So, Paris’ tax basis is as follows: Rental Property$1,000,000 Residence$ 900,000 (½ of $300,000 plus ½ of $1,500,000) (½ of $300,000 plus ½ of $1,500,000) If Paris sold these two properties in 2008 for the same values, then she would not have any income taxes due on the rental property, and would have a taxable gain of $600,000 on her residence. If she used her $250,000 exclusion, she would owe capital gains taxes on $350,000.

5. Second Situation: Assuming the same facts in the first situation, except that they held title as “Community Property with right of survivorship” for both of their properties. Community Property gets a double step up in basis. So, Paris’ tax basis becomes: Rental Property$1,000,000 Residence $1,500,000 If Paris were to sell the properties, she would not have any income taxes to pay.

6. Third Situation: Third Situation: John and Paris were not married, and they held their residence as “Tenants in Common”. Since John owned the rental property himself, then the value would get a complete step up in basis, while the residence would only get a ½ step up. So, the result is the same as the first situation: Rental Property:$1,000,000 Residence:$ 900,000

7. John and Paris set up a revocable living trust and transfered all of their assets into it. The tax basis does not change in this situation (see prior situations for specifics). Fourth Situation:

8. Fifth Situation: Fifth Situation: John and Paris set up an S-corporation for the rental property. Here, the tax situation gets complicated. At John’s death, the S-corporation stock gets a step up in tax basis, not the rental property. So, Paris would not get the added benefit of additional depreciation on this property. However, assuming the stock was held as community property (and no other assets/liabilities were in the corporation), she would enjoy a $1,000,000 income tax basis in the stock.

9. Sixth Situation: John and Paris set up a C-corporation for the rental property. The tax situation is the same as in the previous situation. Only the stock gets a step-up in the basis. However, Paris would also have potential double taxation when the property was sold since the corporation would pay taxes at the corporate level, and then Paris would pay personal taxes when the profits are distributed to her.

10. Seventh Situation: John and Paris set up an LLC for the rental property. Here, Paris will get a complete step up in the income tax basis on the rental property. Assuming Paris makes a special IRS election (Section 754), she will also enjoy increased depreciation deductions based on the new value. The answer is the same if the happy couple had set up a general or limited partnership.

11. Eighth (and last) Situation: John and Paris set up an irrevocable trust and contributed the rental property to it. There are many types of irrevocable trusts, however, the answer is usually the same. The trust’s assets do not get a step up in it’s basis. So, when it is sold, generally there will be a capital gain. If the beneficiary is a non-taxable entity (e.g. charity), then no taxes are due. However, if the beneficiary is taxable (e.g. children), then the taxes will be due.

12. As you can see, how title is held on real estate can make a significant difference in the amount of income taxes paid.

13. 24961 The Old Rd, 2 nd Floor Stevenson Ranch, Ca 91381 Ronald D. Morgan, CPA Ron@sksm.com Tel: (661)286-1040 Fax: (661)286-1050 TOOLS for SUCCESS C-REX.org June 14, 2007