I was talking to two brothers last week who are in a
partnership with their two sisters. The partnership in turn owns undeveloped
land, which it sold last year. The topic of the call was the partnership’s
basis in the land, considering that land ownership had been divided in two and the
partnership sold the property after the death of the two original owners. Oh,
and there was a trust in there, just to add flavor to the stew.
Let’s talk about an issue concerning the basis of property
inherited from an estate.
Normally basis means the same as cost, but not always.
Say for example that you purchased a cabin in western North Carolina 25 years
ago. You paid $250 grand for it. You have made no significant improvements to
the cabin. At this moment your basis is your cost, which is $250 grand.
Let’s add something: you die. The cabin is worth $750
grand.
The basis in the cabin resets to $750 grand. That
means – if your beneficiaries sell it right away – there should be no – or minimal
– gain or loss from the sale. This is a case where basis does not equal cost, and
practitioners refer to it as the “mark to market,” or just “mark” rule, for inherited
assets.
There are, by the way, some assets that do not mark. A
key one is retirement assets, such as 401(k)s and IRAs.
A possible first mark for the siblings’ land was in
the 1980s.
A possible second mark was in the aughts.
And since the property was divided in half, a given half
might not gone through both marks.
There is something in estate tax called the estate tax
exemption. This is a threshold, and only decedents’ estates above that
threshold are subject to tax. The threshold for 2024 is $13.6 million per person
and is twice that if one is married.
That amount is scheduled to come down in 2026 unless
Congress changes the law. I figure that the new amount will be about $7
million. And twice that, of course, if one is married.
COMMENT: I am a tax CPA, but I am not losing sleep over personal estate taxes.
However, the exemption thresholds have not always been so high. Here are selected thresholds early in my career:
|
Estate Tax |
||
|
Year |
Exclusion |
|
|
1986 |
500,000 |
|
|
1987- 1997 |
600,000 |
|
|
1998 |
625,000 |
I would argue that those levels were ridiculously low, as just about anyone who was savings-minded could have been exposed to the estate tax. That is – to me, at least – absurd on its face.
One of our possible marks was in the 1980s, meaning
that we could be dealing with that $500,000 or $600,000 estate threshold.
So what?
Look at the following gibberish from the tax Code. It
is a bit obscure, even for tax practitioners.
Prop Reg 1.1014-10(c):
(3) After-discovered
or omitted property.
(i) Return
under section 6018 filed. In the event property described in paragraph (b)(1)
of this section is discovered after the estate tax return under section 6018
has been filed or otherwise is omitted from that return (after-discovered or
omitted property), the final value of that property is determined under section
(c)(3)(i)(A) or (B) of this section.
(A) Reporting prior to expiration of period of
limitation on assessment. The final value of the after-discovered or omitted
property is determined in accordance with paragraph (c)(1) or (2) of this
section if the executor, prior to the expiration of the period of limitation on
assessment of the tax imposed on the estate by chapter 11, files with the IRS
an initial or supplemental estate tax return under section 6018 reporting the
property.
(B) No reporting prior to expiration of period
of limitation on assessment. If the executor does not report the
after-discovered or omitted property on an initial or supplemental Federal
estate tax return filed prior to the expiration of the period of limitation on
assessment of the tax imposed on the estate by chapter 11, the final value of
that unreported property is zero. See Example 3 of paragraph (e) of this
section.
(ii) No return under section 6018 filed. If no
return described in section 6018 has been filed, and if the inclusion in the
decedent's gross estate of the after-discovered or omitted property would have
generated or increased the estate's tax liability under chapter 11, the final
value, for purposes of section 1014(f), of all property described in paragraph
(b) of this section is zero until the final value is determined under paragraph
(c)(1) or (2) of this section. Specifically, if the executor files a return
pursuant to section 6018(a) or (b) that includes this property or the IRS
determines a value for the property, the final value of all property described
in paragraph (b) of this section includible in the gross estate then is
determined under paragraph (c)(1) or (2) of this section.
This word spill is referred to as the consistent basis
rule.
An easy example is leaving an asset (intentionally or
not) off the estate tax return.
Now there is a binary question:
Would have including the asset in the estate have caused – or increased – the estate tax?
If No, then no harm, no foul.
If Yes, then the rule starts to hurt.
Let’s remain with an easy example: you were already above
the estate exemption threshold, so every additional dollar would have been subject
to estate tax.
What is your basis as a beneficiary in that inherited property?
Zero. It would be zero. There is no mark as the asset
was not reported on an estate tax return otherwise required to be filed.
If you are in an estate tax situation, the consistent
basis rule makes clear the importance of identifying and reporting all assets of
your estate. This becomes even more important when your estate is not yet at –
but is approaching – the level where a return is required.
At $13.6 million per person, that situation is not
going to affect many CPAs.
When the law changes again in a couple of years, it
may affect some, but again not too many, CPAs.
But what if Congress returns the estate exemption to
something ridiculous – perhaps levels like we saw in the 80s and 90s?
Well, the consistent basis rule could start to bite.
What are the odds?
Well, this past week I was discussing the basis of real
estate inherited in the 1980s.
What are the odds?
