Joshua S. Miller, BNY Mellon Wealth Management
The “Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010” (“2010 Tax Relief Act”), passed by Congress on December 17, 2010, made numerous changes to the estate, gift and GST laws. Two such changes were the reinstatement of the estate and GST tax and repeal of carry over basis retroactive to January 1, 2010. Notwithstanding those changes, Congress provided that the executor of the estate of a decedent who died in 2010 may make an election that allows the executor to apply the zero estate tax and carry over basis rules effective under EGTRRA before it was amended by the 2010 Tax Relief Act. Therefore, subject to the basis increase allocations made by the executor discussed below, the basis of the property acquired by the decedent will not step up to its fair market value at death. Instead, the property will be “treated as having been transferred by gift” according to IRC Section 1022 (“Section 1022”).
Section 1022 “allows the executor of … a decedent's estate to allocate additional basis (“Basis Increase”) to increase the basis of certain assets that both are acquired from the decedent and are owned by the decedent … at death.” The executor may allocate up to $1,300,000 in basis increase for qualifying property. In addition, the executor may allocate up to $3,000,000 for “qualified spousal property.” Note that for a nonresident decedent who is not a citizen of the United States the basis increase is limited to $60,000, but the Spousal Property Basis remains at $3,000,000 for qualified spousal property. The election and basis allocations are reported to the IRS using the new form 8939. Form 8939 has yet to be released in its final version. A draft version can be found at http://www.irs.gov/pub/irs-dft/f8939--dft.pdf.
Revenue Procedure 2011-41, recently issued by the IRS, provides a safe harbor to executors who follow the procedures outlined in the Revenue Procedure and provides guidance on the application of the election. Some highlights of the Revenue Procedure are as follows:
1. Section 1022 applies only to property acquired from the decedent (as further set forth in section (4) of the Revenue Procedure).
2. Property acquired from a decedent includes “property acquired by bequest, devise, or inheritance, or by the decedent's estate from the decedent” … “as well as property transferred by the decedent during the decedent's lifetime to a qualified revocable trust.” In addition, it includes “any other property that passes from the decedent by reason of death to the extent that such property passes without consideration.”
3. Property does not include the decedent’s interest in a QTIP funded by the decedent’s predeceased spouse.
4. Exceptions to the above rules include property acquired by the decedent by gift or by transfer for less than adequate consideration during the three year period ending on the decedent’s death (subject to further exceptions as it relates to property transferred to the decedent from the decedent’s spouse).
5. “Basis Increase consists of the sum of the General Basis Increase (Aggregate Basis Increase and Carryovers/Unrealized Losses Increase) and the Spousal Property Basis Increase.”
6. The Spousal Property Basis Increase may be “allocated to property that is sold (regardless of whether the allocation of Spousal Property Basis Increase is made before or after such sale) prior to its distribution.”
7. The Spousal Property Basis Increase may be allocated to property held by a testamentary charitable remainder trust, provided that “the surviving spouse is the sole non-charitable beneficiary of the CRT.”
8. The allocation may be made on a “property-by-property” basis.
9. If the decedent died a resident of a community property state, the executor may allocate the basis increase to the surviving spouse’s one-half of the community property.
10. If an election is made under Section 1022, the decedent’s holding period for that property will be “tacked on” for the purposes of determining capital gains and losses.
11. “The tax character of property acquired from the decedent by a recipient is determined in the same way as the holding period.”
12. The executor may add unused passive losses to the basis of the decedent’s property.
13. “If an executor distributes appreciated property to satisfy a pecuniary bequest, the estate must recognize gain to the extent the FMV of the distributed property on the date of distribution exceeds its FMV on the date of the decedent's death.”
14. The transfer of property by a U.S. person to a foreign estate or trust will be treated as a sale or exchange, even where the executor makes a Section 1022 election, but the allocation of basis will be deemed to occur prior to the transaction.
The purpose of the Revenue Procedure is to provide guidance to executors in: (i) determining the recipient’s basis in property acquired from a decedent and (ii) how basis allocations are to be made under Section 1022. Numerous decisions need to be made to determine how best to allocate the decedent’s basis increase. It is important that the preparer carefully review all decisions as the IRS will not accept an amended Form 8939 after the due date, except in certain specific situations.