Estates of decedents dying in 2010 can choose zero estate tax, but at the price of beneficiaries being limited to the decedents' basis plus certain increases. Because IRS has yet to issue guidance in this area, an individual who inherited and sold property last year may have difficulty in figuring gain or loss on the sale. Information recently posted on IRS's website explains how such beneficiaries should proceed.
Background. Under the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), the estate tax was to have been repealed for individuals dying in 2010, and the rules allowing a step-up in basis for property acquired from a decedent were to have been replaced with a modified carryover basis regime. The 2010 Tax Relief Act restored the estate tax for individuals dying in 2010 with a $5 million per person exemption and a maximum rate of 35%. It also repealed the modified carryover basis rules for property acquired from a decedent who died in 2010. However, Sec. 301(c) of the 2010 Tax Relief Act allows estates of individuals dying in 2010 to elect zero estate tax and the modified carryover basis rules that would have applied before they were repealed.
Under the modified carryover basis rules, the basis of assets acquired from the decedent is the lesser of the decedent's adjusted basis (carryover basis) or the fair market value of the property on the date of the decedent's death. However, there are two exceptions to this general rule:
... The executor can allocate up to $1.3 million, increased by unused losses and loss carryovers ($60,000 in the case of a decedent nonresident who is not a citizen of the United States, but with no loss or loss carryover increase), to increase the basis of assets; and
... The executor can also allocate an additional amount, up to $3 million, to increase the basis of assets passing to a surviving spouse, either outright or in a Qualified Terminable Interest Property (QTIP) trust.
A few weeks ago, IRS said it plans to issue future guidance that will provide a deadline for filing Form 8939 and for electing to have the estate tax rules not apply to the estates of persons who died in 2010. The guidance will also explain the manner in which an executor of an estate may elect to have the estate tax not apply.
Filing advice for beneficiaries who inherited and sold property in 2010. IRS notes that as of the Apr. 18, 2011 due date for filing income tax returns for 2010, a beneficiary may not know whether the executor will elect not to have the estate tax rules apply to the decedent's estate. As a result, if the beneficiary acquired property from a decedent who died in 2010 and sold the property in 2010, IRS says the beneficiary may need to file, by Apr. 18, 2011, an extension to file his income tax return. The beneficiary is advised to estimate the gain or loss from the sale, and make any other estimates for the acquired property necessary to compute tax. If additional tax is owed because the estimate turns out to be incorrect, IRS will provide penalty relief if the estimate was based on a reasonable interpretation of the law. Interest, however, will accrue.
Observation: The need to do this will primarily affect beneficiaries of very large estates. That's because larger estates may owe less combined estate and income taxes for the estate and its beneficiaries as a result of making the election.
Illustration: Smith, a single individual, dies in 2010 with an estate worth $6 million and with a basis of $3.7 million. Without the election, his heirs would face an estate tax of $350,000 ($2,080,800 tax on $6 million reduced by $1,730,800 tax offset by applicable exclusion amount), and they would get a step-up in basis. If the executor were to make the election, the estate would owe no estate tax and his heirs would face income tax on $1 million worth of assets when they sell them. This is the $6 million they inherit less a basis of $5 million (Smith's original $3.7 million basis as increased by $1.3 million under the modified carryover basis rules). Assuming the $1 million were taxed at 15%, the income tax cost would be $150,000. Thus, the election would result in lower combined estate and income tax ($150,000 as opposed to $350,000).