Estate Tax Repeal Consequence: Carry Over Basis

12/17/2010 - The income, estate, & gift taxes have been modified for 2010, 2011 & 2012 by the Tax Relief Act of 2010.

Although the “repeal of the repeal” of the estate tax is apparently not going to happen, and estates of persons dying in 2010 are apparently going to pass tax free, there are still tax consequences related to death in 2010.

One negative trade-off for the repeal of the estate tax was the elimination of “stepped-up” cost basis which in the past has allowed heirs, devisees and beneficiaries to receive assets with a cost basis equal to the date of death value. This stepped-up basis eliminated capital gain on appreciation of assets while owned by the decedent presumably in recognition of the fact that the appreciation was taxed part of the estate value.

For decedents dying in 2010, their basis will “carry-over” from the decedent; i.e., heirs, devisees and beneficiaries will receive the assets with the same cost basis that the decedent had, meaning that upon disposition of those assets they will recognize gain on the appreciation that occurred both while held by the decedent, as well as while held by the recipient.

The law does provide some relief from the carry-over basis for smaller estates; a $1,300,000 maximum “aggregate basis increase,” and a $3,000,000 maximum “spousal property basis” increase. The aggregate basis increase can be allocated to any of the decedent’s property, whereas the spousal property basis increase only applies to property either passing outright to the surviving spouse or which is “qualified terminable interest property”; i.e., property held in a trust for the surviving spouse so as to qualify for the estate tax marital deduction in effect prior to the repeal of the estate tax.

An information tax return under IRC §6018 will be required for estates that exceed $1,300,000, excluding cash. That return must report the fair market value at date of death and decedent’s cost basis in those assets, and it must allocate the cost basis increases described above to those assets. The “executor” of the estate makes these allocations and files the required return. There are no restrictions imposed on how the executor allocates the basis increases, and once they are made they can only be changed as provided by the Secretary of the Treasury. In addition to having timing implications, (one might prefer to allocate to assets that might be sold first), there is also the question of fairness among multiple recipients with respect to the $1,300,000 aggregate basis increase. The tax law doesn’t deal with this, and presumably it will have to be dealt with as a fiduciary issue under state law.

For estates that are not required to file a return (non-cash assets under $1,300,000), since there is no return required, the $1,300,000 aggregate basis increase is presumably automatically allocated to increase the basis of those assets to their fair market value at date of death. Note that the $1,300,000 and $3,000,000 amounts are aggregate maximums and no asset can have its basis increased above its fair market value at date of death.

If the estate tax comes back in 2011, which now appears to be almost inevitable, the imposition of carry-over basis for decedents dying in a single year, 2010, seems illogical, potentially confusing and inefficient. Congress could repeal carry-over basis for 2010, but weighing against that is the fact that the recipients of those estates will have received what is generally viewed as a windfall resulting from the repeal of the estate tax, and it seems unlikely Congress will be willing to bestow an additional benefit by repealing carry-over basis in order to avoid the one year deviation from the historical stepped up basis treatment.

This brief overview of some important considerations associated with the estate tax repeal & carry over basis is by no means comprehensive. Always seek the advice of a competent professional when making important estate tax decisions.

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