Tax Legislation Update: Estate Tax Planning: The Latest on Basis
By Nancy Faussett, CPA
Publication Date: 08/04/2010
Estate planning became a great deal more complicated when the Economic Growth and Tax Relief Reconciliation Act (EGTRRA) was signed into law in 2001. One of its most notable provisions was the temporary elimination of the estate tax for decedents dying after December 31, 2009 (and before January 1, 2011). However, for estate tax planning purposes, as well as for wealth management, the ensuing headaches are largely due to the creation of a new IRS Code Section 1022, which completely changes the basis rules for assets inherited after 2009. For such property, new carryover rules for determining an heir’s basis replace the old “step up in basis” rule. In fact, more taxpayers will be affected by these new basis rules than the repeal of the estate tax.
Prior to the creation of Section 1022, property inherited before 2010 was valued at its fair market value (FMV) either on the date of death or, if the executor elected, the alternative valuation date (generally six months later). This is known as a step up in basis.
Now we have arrived in 2010 and new rules apply. Section 1022 states that a taxpayer’s basis in inherited property is the lesser of:
- The decedent’s adjusted basis in the property (i.e., a carryover basis), or
- The FMV of the property as of the date of the decedent’s death.
If the property, as is often the case, has substantially appreciated since the decedent originally acquired it, it will now have a relatively low carryover basis for the heir. The result is a much higher gain if the heir later sells the property. In fact, such a gain could actually result in a much larger tax liability than if the estate tax had applied.
Congress was, in fact, aware of this possibility and decided to lessen the law’s impact by allowing an estate, after 2009, to increase the basis of inherited property, determined on an asset-by-asset basis, up to a total of $1.3 million and the amount, if any, of the decedent’s unused capital losses, net operating losses, and certain built-in losses. Furthermore, if the property is being transferred to a surviving spouse, there is an additional $3 million of increase allowed, for a total of $4.3 million. There is a provision to adjust these amounts for inflation after 2010, even though there is a sunset provision in EGTRRA, taking effect in 2011, which repeals both the estate tax and the carryover basis rules for inherited property. Be aware that the tax basis of an asset cannot be increased above its FMV on the day of death.
All of the above leaves estate tax planners in a quandary. Will the estate tax elimination be extended past 2010? Will it be reinstated as it was in 2009? Or will the rules be changed once again? And, what will happen to the basis rules? It appears that if Congress should decide to extend the estate tax repeal beyond 2010, it would also extend the carryover rule for basis. For 2010, tax planners must devote a good deal of their attention to any unrealized appreciation in property currently owned by their clients rather than looking at the property’s FMV, a vexing problem indeed. Congress still cannot seem to decide what to do with the estate tax. The longer they wait, the larger the headache is for anyone trying to put together an estate plan. Thousands of estates are facing increased compliance issues because of the change in law, with many of these individuals also seeing larger tax bills than they would have under the old estate tax. All of this makes knowledgeable estate planning even more essential.
Meanwhile, anyone inheriting property in 2010 must use the lesser of the decedent’s basis in the property or its fair market value on the date of death. That basis can then be increased, although not by more than its FMV, by another $1.3 million (or, if a spouse, by $4.3 million). All of this may change again in 2011.
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