This time last year, we were putting together material for newsletters and seminars on how the 2010 Tax Relief Act changed the estate planning landscape. One of these changes was to give personal representatives of estates of decedents who died in 2010 a choice:
- Under the default rules, the estate would pay a 35 percent estate tax on assets that exceed the $5 million exemption and the beneficiaries would take a stepped-up basis in the property; or
- The personal representative could elect to pay no estate tax, but would forfeit the full basis step-up. Instead, the estate would be able to step up basis of up to $3 million for property left to a spouse and $1.3 million for property left to anyone.
In other words, executors had to choose between applying the prior law, which repealed the estate tax and introduced a modified carry-over basis system, and the new law, which reinstated the estate tax and returned to a stepped-up basis system.
We noted at the time that this election would add complexity (and liability) for tax return preparers, attorneys, and other financial advisors involved in administering the estates of decedents who died in 2010. We have seen a few of these issues come to fruition over the past year.
Cost Basis Determination and Allocation
The modified carryover basis system introduced by EGTRRA did away with the unlimited step-up in basis in property inherited from a decedent in 2010. Instead, taxpayers would take a “carryover” basis equal to the lesser of the decedent’s adjusted basis or the fair market value on decedent’s date of death. There were two notable exceptions to this rule:
- Each taxpayer received $1.3 million ($60,000 for non-resident non-citizens) of basis increase that can be allocated among his or her assets at death; and
- Each taxpayer received a $3 million basis increase for qualified spousal property.
This means that executors that elect for EGTRRA to apply must both determine the decedent’s basis in assets and allocate the basis increases among the decedent’s assets. As expected, this has proven to be challenging. In many cases, the decedent’s primary capital assets have been owned for decades. The decedent’s acquisition costs and the value of various capital improvements have not always been well-documented. This leaves executors with the task of reconstructing the financial history of the decedent’s assets with very little to go on.
Executors also have to decide how to allocate the basis increases among the decedent’s assets. To do this, executors must determine when the assets are most likely to be sold and allocate the basis in a way that will achieve the optimum tax result. This places a significant burden on executors by requiring judgment calls that are often based on incomplete information.
IRS Guidance and (Finally) Form 8939
Midway through the year, the IRS published Revenue Procedure 2011-41, which gives personal representatives safe harbor guidance on basis allocation. Under the Revenue Procedure, the $1.3 million and $3 million basis step-ups can be increased by the amount of the decedent’s unused net operating loss and capital loss carryovers. If the decedent owned loss assets (assets worth less than their basis), the amount of the loss can also be added to the basis step up.
The Revenue Procedure also provides that when a beneficiary allocates basis to a depreciable asset, the added basis is treated as though it were part of a new asset that was first placed in use on the decedent’s death.
Personal representatives were required to report basis allocations by November 15. The IRS released a draft form for this purposes (Form 8939) early in the year, but was slow to release a final version. Although the IRS stated that the form would not be due until 90 days after it was first issued, practitioners worried that the form would inject further complication into the situation. A few weeks before the November 15 deadline, the IRS extended the Form 8939 due date to January 17, 2012. A few weeks later, the IRS released the final Form 8939. Thankfully, form is straightforward and doesn’t introduce unexpected complications. You can view the form here.
