Higher federal income taxes on inherited property in 2010 and beyond

By Frank Minuti, CPA

Federal tax reform in 1948 gave an unlimited “step-up “in the tax basis of all assets inherited from a decedent’s estate. This meant that if a decedent owned assets with tax (net cost) basis of $1,000,000 and a fair market value of $3,500,000 at the date of death, the beneficiary(s) would receive a tax basis of $3,500,000 in that asset. A subsequent sale by the beneficiary(s) at $3,500,000 would result in no taxable gain.

This section of the Internal Revenue Code was repealed by the Economic and Tax Relief Reconciliation Act of 2001 for decedents passing away after 2009. The 2001 Act limits the step-up in basis to a maximum of $1,300,000 for decedents in 2010 and beyond. The executors or administrators of estates with more than $1,300,000 in appreciated assets, in the estate, can choose how they allocate the $1,300,000 between the appreciated assets.

The result of this repeal is that the beneficiary(s) of estates of single individuals that have assets that have appreciated more than $1,300,000 as of the date of death could be subject to greater federal income taxes when they sell these assets.

In the prior example of the sale of the inherited property for $3,500,000 if the death after 2009 the taxable gain would be $1,700,000. The basis is calculated by increasing the $1,000,000 of cost basis to include the $1,300,000 basis step-up from the sale price. This increases the basis to only $2,300,000 and results in a taxable gain of $1,200,000.

The 2001 act grants an additional $3,000,000 in basis step-up for property inherited from a spouse. California has not conformed to the federal repeal of the basis step-up. Therefore executors and administrators of decedents will now have to obtain both the decedents original tax basis in the asset as well as the fair market value of the assets on the date of death.

In light of these changes, taxpayers should consult with their tax advisors to determine how these changes will affect them and plan their best course of action.

We should all encourage our Congressmen, Senators and the President to act promptly to retroactively restore this provision of the federal tax code.