Thursday, September 15, 2011

Property Inherited in 2010: Carryover (Step-Up) Basis Rules

The federal estate tax has undergone several changes in recent years. We had an estate tax in 2009, and none in 2010. In December of 2010, Congress retroactively enacted an estate tax for 2010, but gave executors options to determine basis of assets inherited from a decedent.
In a legislative compromise at the end of 2010, congress retroactively reinstated the estate tax to apply to decedents who died in 2010. However, an important feature of the law that revived the estate tax is that it gave executors of estates of decedents who died in 2010 a choice. The executor can either:
(a) have the new estate tax rules ($5 million exemption, with a flat rate of 35% imposed on all transfers over that amount) apply to the estate, in which case the traditional stepped-up basis rules (which provide that the basis of assets received from a decedent is equal to the value of such assets on the date of the decedent's death) would apply in determining the basis of property acquired from the decedent; OR
(b) elect not to be subject to the estate tax, meaning that the estate would pass to the heirs free from estate tax, but the modified carryover basis rules (discussed below) would apply in determining the basis of property acquired from the decedent.
Modified Carryover Basis Rules
Under the modified carryover basis rules IRC Sec. 1022, the basis of property acquired from an individual dying in 2010, in the hands of the person acquiring it, generally is the lower of the fair market value on the date of the decedent's death or the adjusted basis of the property immediately before the death of the decedent.

For example, the decedent died on Jan. 1, 2010, owning 200 shares of Corporation Y stock having a fair market value of $40,000. His adjusted basis in the stock immediately before his death was $30,000, which was the amount he paid for the 200 shares several years ago. Absent from a permitted basis increase for the stock, the basis of the Corporation Y stock in the hands of the person acquiring it from the decedent is $30,000. Now, assume the stock is worth $20,000 on the date of decedent's death. Under the modified basis rule, the basis in the hands of the person acquiring or receiving it would be $20,000.
The basis of property determined under the modified basis rule (i.e., the lesser of adjusted basis or fair market value) is increased by a general basis increase amount of $1.3 million. In other words, each estate receives a $1.3 million of basis plus more (depending on marital status at time of death and other circumstances) to be added to the carryover basis of any one or more of the assets held at death. However, no addition to basis can increase the new basis of any asset above its fair market value on the date of death.
The allocations of the general basis increase and other increases must be made by the executor, or other person in possession of a decedent's property, and must be reported to IRS and the property recipients.
Generally, if an estate is less than or equal to $5,000,000 ($10,000,000 for a married couple), the likely choice will be to apply the retroactive estate tax and remain subject to the estate tax rules (and receive the step-up in basis to date-of-death fair market value). However, in many cases, the circumstances will be more complex and will require careful analysis to determine whether or not to elect out of the default estate tax rules. For these situations, other specific factors will be considered and decisions will depend on each person’s specific circumstances.
By way of an announcement on September 13, 2011, the IRS pushed back the due date of these estate tax returns. The returns are now due March 19, 2012.
Please contact Frank Brunetti with any concerns or help that you may need with any of the aforementioned issues.
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