Tuesday, June 21, 2011

What Is the Tax Basis of an Asset Inherited in 2010?

The answer is: it depends.

We have two co-existing estate tax systems in place for 2010. One system imposes no federal estate tax, but at the cost of putting limits on the step-up of any inherited assets. The other imposes an estate tax, but with no limit on the step-up. The estate gets to decide.

We are used to thinking that the tax basis of an inherited tax asset is the value on the date of death. The idea is that the estate already paid tax, so to have the beneficiary pay tax again on any sale soon after the death would be unfair. The estate therefore gets to step-up the basis of the asset, preventing any appreciation in the asset (through the date of death) from being taxed again.

The dividing line is $5 million. When Congress changed the law late in 2010, it resurrected the estate tax but with a $5 million exemption. Therefore, an estate under $5 million would opt-in to the new tax law, increase the basis of any assets and pay no federal tax. Best result!

An estate over $5 million has to decide. If it opts-in, then there will be federal estate tax to pay. If it opts-out, there will be no federal estate tax but the step-up may be limited. The limits are as follows:

(1) All estates get a step-up up to $1.3 million

If the appreciation is $1.3 million or less, then the estate would opt-in. The end result is the same as opting out, as there is only so much step-up in the assets anyway.

If the appreciation is more than $1.3 million, then step-up is limited. And the estate has a decision to make.

(2) If there is a surviving spouse and the spouse receives estate assets…

Then there is an additional $3 million step-up for assets passing to the surviving spouse.

How would a beneficiary know what the estate did? Well, there is a new form – Form 8939. The executor of the (larger) estate will fill-out this form and send a copy to the beneficiaries. The problem is that the form has not yet been finalized by the IRS. If one sold an asset in 2010 – and that asset was inherited from someone who passed way in 2010 – it is likely that he/she will have to file for an income tax extension and wait on receiving this form from the executor.

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