How to handle carryover basis in 2010Article added by Julius Giarmarco on October 7, 2010
Julius Giarmarco

Julius Giarmarco

Troy, MI

Joined: July 07, 2008

It appears increasingly unlikely that Congress will restore the estate tax retroactively this year. And, even if the estate tax is restored, the Obama Administration is considering giving estates a choice of whether to apply the new rules (i.e., an estate tax exemption with a complete step-up in basis) or the 2010 rules (i.e., no estate tax with a limited step-up in basis). Therefore, estate planners must learn how to deal with the new carryover basis rules for estates of persons who died this year.

Under the 2010 rules, property acquired from a decedent dying this year will be stepped-up by an aggregate amount of $1.3 million, and property passing to the decedent's spouse (or to certain marital trusts) will be stepped-up by an aggregate amount of $3 million. While this appears to be somewhat straightforward, the attorneys, accountants, trustees and executors handling the estates of decedents who died this year must deal with several issues.

First, basis consists not only of the purchase price, but also of the costs of capital improvements. Many heirs will have a difficult time determining such costs. It's not uncommon for records of costs and improvements to be lost or perhaps even non-existent. And, if basis cannot be proved, the IRS may assume the cost basis is zero.

Second, in years past, executors and trustees of decedents' estates were anxious to sell assets quickly to eliminate market risk (as well as potential fiduciary liability) — particularly where concentrated positions were held. Now, executors and trustees must weigh the impact of capital gains taxes when deciding to sell assets.

Third, in the unlikely event the estate tax is restored retroactively, the estate may need cash to pay the same. Alternatively, if the 2010 rules will stay, the estate may need cash to pay capital gains taxes. Thus, fiduciaries may be well advised to postpone distributions until the end of the year (despite possibly arousing the ire of the beneficiaries).

Fourth, the deadline for reporting carryover basis is April 15, 2011, with a possible extension to October 15, 2011. But the IRS has not yet issued the form to be used to indicate which assets are to receive a step-up in basis (and the amount of step-up). It's likely that the IRS will require each asset to be listed, along with its basis and date of death value. Thus, as in past years, hard-to-value assets will have to be appraised — not to determine the estate tax, but for basis allocation purposes (since you cannot allocate basis in excess of fair market value (FMV)). It's also important to note that there is no basis adjustment on income in respect of a decedent (IRD). And, while the $3 million basis allowance for spouses applies to outright bequests and transfers to certain kinds of marital trusts, it cannot be used for a trust that benefits persons other than the spouse.

Finally, fiduciaries and their advisors will have to deal with the troublesome issue of how to use the $1.3 million basis allowance. It's unlikely that many wills and trusts will provide guidance to the fiduciaries as to how to allocate this allowance. On the surface, it would appear to make sense to apply it to those assets likely to be sold first. But, depending on the terms of the will or trust, this could benefit some heirs over others. The problem is compounded when the fiduciary is also a beneficiary because of the possible conflict of interest.

In summary, the 2010 rules definitely complicate matters for fiduciaries and their advisors. They also increase the risk of fiduciary liability and legal malpractice. To make matters worse, the 2010 rules may be around for only one year. Thus, fiduciaries and their advisors are well advised to discuss their recommendations with the beneficiaries, ask them what they want to do, and document those conversations with follow up letters and notes to the file.
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