With the 2010 repeal of the federal estate tax, the rules for determining income tax basis on inherited property became more complicated for deaths occurring in 2010. The income tax basis of a property is used for determining capital gains when an asset is sold and depreciation. In prior years and in future years, the estate’s basis in the property is the fair market value at date of death, regardless of whether this is an increase or decrease in the decedent’s basis.
The basis of inherited assets in 2010 will be determined by a complicated process beginning at the lesser of the decedent’s basis in the property or the fair market value of the property on date of death. Thus for some, the basis still may be decreased, particularly for stocks that have decreased in value. For assets whose basis is still less than the fair market value, each estate of a U.S. citizen or resident has $1,300,000 of basis to add to the decedent’s existing basis. If property passes to a surviving spouse either outright or in a qualified terminable interest, the estate has another $3,000,000 of basis that the executor may allocate. The additional basis amount is increased by capital loss and net operating loss carryovers of the decedent and certain calculated losses. For non-resident aliens, the executor only has $60,000 of basis to allocate. The executor may not increase the basis of any asset to more than the fair market value of the property at date of death.
For example, if a U.S. citizen or resident has a $2,000,000 estate with a $700,000 basis before death, the entire estate would receive a full step-up in basis. If the pre-death basis was $200,000 and the assets do not pass to a spouse, there would not be a full basis step up. The estate would have only $1,500,000 of basis. The executor should be able to select the assets to which the executor allocates the basis.
The executor may not allocate basis to any property acquired by the decedent within three years of date of death if the property was acquired by gift or inter vivos transfer for less than full and adequate consideration, except for certain property that was received by gift from a spouse. This expands the old rules in a couple of ways. The old rules only applied to property acquired within one year of death and only if the property returned to the same person.
As under the old rules, the executor may not allocate basis to any property that falls within the definition of income in respect of a decedent, such as ordinary IRAs or other taxable retirement accounts.
The rules for 2010 can be a record keeping nightmare. Many people do not know the current basis of their property, and their children or heirs may have an even harder time finding the appropriate records. Executors may need to dig through several decades of records.
The IRS indicates on its website the following information. Executors must file an information return if the property acquired from the decedent exceeds $1,300,000 or if the decedent acquired certain property by gift within three years of death. The information return is used to report the carryover basis of the decedent’s property and the allocation of the basis increase allowed under the new basis rules.
The new information return is due with the decedent’s final income tax return. Generally, this means that for decedent’s dying in 2010, the due date is April 15, 2011. The IRS has not yet released the new form. Failure to file this information return may result in a penalty of $10,000.
In addition, executors must provide to each beneficiary a written statement that lists the information reported on the information return with respect to the property that the beneficiary acquired from the decedent. The executor must furnish the beneficiaries with this statement no later than 30 days after the filing of the estate information return. Failure to provide each beneficiary with this statement may result in a penalty of $50 for each failure.
However, it is important to note that a similar basis system enacted for decedents’ estates with dates of death after 1976 was postponed so that it did not apply to any dates of death before 1980 and then was retroactively repealed. Accordingly, you will want to continue to monitor these rules as Congress addresses the estate tax system in the coming months… or years.