In the Estate Planning Insights column for October 2009, I explained the “stepped up basis.” When a person dies owning property such as real estate or stocks, the fair market value of that property on the date of death will become the new tax basis of that property. You may review the October 2009 article on this subject by going to www.new.okuralaw.com.
However, if anyone dies in the year 2010, those inheriting property should understand the special rules which apply only to deaths in 2010, called “Modified Carryover Basis” rules. The general rule is that when a person dies owning property, the tax basis in the property will be the decedent’s (deceased person’s) basis or the fair market value at date of death, whichever is lower. However, the basis of property can be increased up to $1.3 million (but not above fair market value at death), and in addition, property inherited by a surviving spouse can be increased up to $3 million. (Actually, the basis of property can be increased up to $1.3 million, plus the sum of the decedent’s unused capital loss carryovers, net operating loss carryovers, and the decedent’s unrealized losses on property owned on the date of death.) For most people who are not multi-millionaires, there will be a stepped up basis in the year 2010. If the allowed basis increase is less than the appreciation of the properties, the executor can decide how much basis increase to allocate to each property. Unfortunately, if the person died with only a life estate in property, there would not be a stepped up basis. To get the stepped up basis in 2010, as a general rule, the property must have been owned by the decedent outright, in a revocable trust, or as a joint tenant or tenant by the entirety. If all property (other than cash) acquired from a decedent is more than $1,300,000, a report must be given to the IRS and the beneficiaries. The penalty for a late report is $10,000!
Let’s look at some examples. Suppose someone dies in 2010 with a home that was bought for $200,000, which is worth $600,000 on the date of death. Since the increase in value is $400,000, which is less than $1,300,000, the home gets a stepped up basis to $600,000. In other words, if the children ever sell the home, they have to pay capital gains taxes only if they sell it for more than $600,000.
Suppose a person dies in 2010 with 2 parcels of real estate. In one, the decedent had a basis of $500,000 and it is worth $2,000,000 on the date of death. This property is inherited by the daughter. In the other the decedent had a basis of $1,000,000 and it is worth $4,000,000 on the date of death. This property is inherited by the surviving spouse. The property inherited by the daughter can get a maximum basis increase of $1,300,000, so the new basis in her property will be $1,800,000. Since property inherited by a surviving spouse can get a step up in basis of up to $3,000,000, her property would get the full new basis of $4,000,000.
Suppose a person dies this month owning real estate and stock, which are inherited by the son. The real estate, bought for $1,000,000, is now worth $3,000,000. The stock, bought for $1,000,000, is now worth $200,000. The basis in the real estate can be increased by $1,300,000 plus unrealized losses on property, but not more than to fair market value on the date of death. The stock has unrealized loss of $800,000. The basis in the real estate can increase by $1,300,000 (allowed for everyone) + $800,000 (unrealized loss in the stock), for a total of $2,100,000, but not above the fair market value of $3,000,000. Therefore, the basis of the real estate can be increased only to $3,000,000, which is the fair market value on the date of death.