Special $3 Million Increase for Property Passing to a Spouse
If the property in question passes to the decedent’s spouse, it may qualify for an additional (unrelated to the $1.3 million basis increase) $3 million basis adjustment. Similar to the $1.3 million basis step, this is another major modification of the general carryover basis rules.
The amount of pre-death appreciation that can receive a step up in basis, if everything is left to a surviving spouse, is $4.3 million ($1.3 million plus $3 million). This amount can be increased further, if the special home sale exclusion rules discussed next are also considered.
This increase is available, of course, if there is a surviving spouse. Thus, the estate tax laws will continue the substantial favoritism historically shown to married couples.
If the entire estate is funded to a family trust, similar to a bypass trust used under prior law, then the trust may not meet the requirements of Qualified Spousal Property (QSP) if there are other beneficiaries, and the spouse is not receiving the appropriate income interest.
If the estate is funded to a family trust, but not to exceed $1.3 million in appreciated assets, and the balance is funded to a marital trust (a Qualified Terminable Interest Property, “QTIP” trust) that qualifies as a QSP (i.e., Qualified Spousal Property, so that the $3 million basis adjustment can be used), the estate could benefit from both types of basis adjustments. Another approach that might have been used, would be for the will to have bequeathed all assets to a QTIP trust.
Requirements to Qualify for a $3 Million Spousal Basis Adjustment
In order for assets to qualify for the basis step up, they must be “qualified spousal property” (“QSP”). Congress knew instinctively that taxpayers needed more estate tax acronyms to keep the rules confusing! QSPs include QTIPs or outright transfers of property to a surviving spouse.
Qualified Terminable Interest Property (QTIP) qualifies as a QSP, and thus for the $3 million spousal basis adjustment.This is a commonly used marital trust from which the surviving spouse will receive income for life, and which is funded with property that passes from the decedent. This requires that the surviving spouse be entitled to receive all of the income from the assets in this trust, payable to him/her at least annually. Alternatively, the surviving spouse may have an interest for life in the property. No person can be given a power to appoint any part of the QTIP assets to anyone other than the surviving spouse during the surviving spouse's lifetime. This means giving a power to someone to appoint the QTIP property after the death of the surviving spouse will not disqualify those assets from the $3 million basis step up.
A husband’s will bequeaths $15 million of assets with a $12 million tax basis, and hence $3 million of pre-death appreciation, to a QTIP trust for his third wife. Husband wants the assets to be distributed to the children from his first marriage upon third wife's later death, but he is not certain in what proportions or how (i.e., in trust or not). He gives his brother a limited power of appointment to designate the proportions and when the class of persons consisting of his children from his first marriage may receive these assets. If this power is exercisable during his third wife's lifetime, the assets bequeathed to the QTIP will not qualify for the $3 million basis step up.On the other hand, if this power is only exercisable after the third wife dies, the assets, so bequeathed, should qualify. The definitions of different types of powers of appointment will no longer appear in the tax laws if the estate tax is eliminated.
In determining whether payments to the surviving spouse will qualify as constituting all the income payable at least annually, the new law directs the IRS to issue regulations governing how an annuity will qualify as the appropriate type of income interest. In determining whether a transfer of property qualifies for QTIP treatment, an interest in property, such as a fractional or percentage share, will qualify. Given the very limited applicability of the carryover basis rules to only a handful of large 2010 estates for which the appreciation is significant, and the difficulties the IRS had even issuing a form for the carryover basis rules (Form 8939 was issued in late 2010 then withdrawn, and then issued again on December 16, 2010, as a draft), regulations are unlikely to be issued.
Outright Transfer of Property to Surviving Spouse Qualifies for Spousal $3 Million Basis Step Up
An outright transfer of property to the surviving spouse qualifies as QSP. This is basically property that is transferred outright to the surviving spouse. More technically, this is any property “acquired from” the decedent as that term was defined in the preceding discussions. Property will not qualify for the $3 million basis adjustment as "outright transfer property" if the interests passing to the surviving spouse will lapse on the occurrence of an event or contingency, the failure of an event or contingency to occur, or the lapse of time.
If the termination is because of the death of the surviving spouse under a simultaneous death clause (a provision that states which spouse should be presumed to have died first in the event both spouses die from a common disaster or at approximately the same time), or if the surviving spouse dies within six months of the date of the first spouse's death the asset is passed elsewhere, these conditions will not prevent the benefit of the $3 million spousal basis adjustment.
Property Must Be Owned by Decedent to Qualify for Basis Increase
To qualify for the spousal basis increase, the assets involved had to be owned by the deceased spouse on his or her death.If property was owned jointly by the deceased spouse and the surviving spouse, the decedent will be presumed to have owned one-half of the property. If the property is owned by the decedent and a joint tenant who is not the decedent's spouse, then the property will be treated as owned by the decedent based on the proportion of the value contributed to the property's acquisition by the decedent.
: A husband and his friend purchased land for $5 million, with the husband contributing $3 million and his friend contributing $2 million. The husband will be treated as owning 3/5ths of the property.
The decedent will be treated as owning property held in a qualified revocable trust (QRT) which the decedent funded during his lifetime with assets. This is in general terms the popular revocable living trust.
The decedent will not be deemed the owner of assets because of his possessing a power of appointment over those assets.
The actual mechanics of this spousal basis adjustment are that a portion of the "aggregate spousal basis increase" is to be allocated under the new allocation rules, to each qualifying asset. The aggregate spousal basis increase in 2010 is $3 million, plus, any increase in the $3 million for inflation. Since the carryover basis rules will hopefully never apply again (other than this limited application to electing estates in 2010), inflation adjustments will hopefully never need to be addressed.