$1.3 Million 2010 Carryover Basis General Adjustment
By by Martin M. Shenkman, CPA, MBA, JD
General Increase of $1.3 Million in Tax Basis
One of the major exceptions the new law provides to the general carryover basis concept, is that every estate can increase the basis of assets to eliminate $1.3 million of taxable appreciation.
Example: The taxpayer’s estate consists of a house worth $600,000, for which she paid only $300,000 (her tax basis), and stocks worth $2.5 million, for which she paid $1.5 million (his tax basis), and other non-appreciated assets that push the estate to a level that the carryover basis regime is prudent to elect by the executor. The executor can allocate $300,000 of special basis adjustment to increase the basis in the house to its $600,000 fair value, effectively eliminating any gain. The executor can also allocate $1 million of special basis adjustment to the securities, thus effectively eliminating any gain. When the estate utilizes this special "modified" carryover basis rule, heirs will not have to pay capital gains tax on the pre-death appreciation when they sell the assets. Without this special tax break, the $1.3 million in appreciation could have ultimately cost heirs a capital gains tax (depending on future increases in capital gains rates).
The purpose of the $1.3 million basis adjust rule was to prevent the majority of estates from bearing the burden of passing on capital gains tax to their heirs, and the commensurate record keeping complexity. However, since the TRA has made the estate tax retroactive, the purpose behind the $1.3 million basis is academic, and if Congress prevents its recurrence in 2013 and later, it will be safely ignored by all but estate tax archaeologists.
Estates with a value over $5 million will generally choose the carryover basis regime to avoid 2010 estate tax. For those electing estates, if they do not have more than $1.3 million in pre-death appreciation, heirs will have the best of both worlds – no estate tax and a full basis step up.
The actual mechanics of this special basis adjustment are somewhat more complicated, and involve a bit of jargon. The basis increase allocated to a particular asset is the "aggregate basis increase" allocated under the new allocation rules, to that asset. (IRC Section 1022(b)(2)(A)). The aggregate basis increase in 2010 is:
$1.3 million, as explained previously.
Plus, any increase in the $1.3 million (adjusted for inflation).
Plus, any capital loss carryovers.
Plus, any net operating loss carryovers under Code §172. These are taken into account to the extent that these losses would have been permitted to be carried over from the decedent's last income tax return to the next year's income tax return, had the decedent lived.
Plus, any loss deductions for built-in losses that would have been permitted as deductions (under Code §165) as if the property inherited from the decedent had, instead, been sold for its fair value prior to the decedent's death.
The rules apply to all property “acquired from the decedent.” Thus, joint assets, assets held in QRTs, and so on, will all be subject to these new allocation rules. However, the executor of an estate only has the legal right to make decisions concerning probate assets. Non-probate assets will thus present a particular challenge.
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