The general rule, which is usually favorable to taxpayers, is that the beneficiary’s basis for inherited property is stepped up (or stepped down) from the decedent’s cost to the asset’s fair market value at the decedent’s date of death. In contrast, the basis for property received by gift during the donor’s lifetime is not stepped up or stepped down. Instead, the basis for gifted property depends upon whether the basis is being calculated for purposes of determining gain or loss.
For determining gain, the donee’s basis is the same as the donor’s basis (i.e., carryover basis). But for determining loss, the donee’s basis is the lesser of (1) the donor’s basis or (2) the fair market value of the asset on the date of the gift. With the estate tax exemption at $5.45 million per decedent (for 2016), for nearly 99% of Americans, the tax component of estate planning has shifted from estate taxes to income taxes and tax basis.
For years, taxpayers have successfully used family limited partnerships, family limited liability companies, non-voting stock, fractional interests and other elaborate structures to discount the value of assets for estate and gift tax purposes. Tax practitioners should expect that the IRS will apply valuation discounts to reduce the FMV of gifted assets and, therefore, the tax basis of assets passing in a non-taxable estate. The net result is to increase the capital gains tax on a subsequent sale of the assets. Accordingly, it may make sense to reverse valuation discount techniques if the donor now has a non-taxable estate.
There are no federal laws or rules mandating that fiduciaries provide tax basis records to beneficiaries. Thus, consider providing in wills or trusts a provision requiring the fiduciary to provide tax basis information to the beneficiaries to the extent available. And when making lifetime gifts, the donor should provide the donee with supporting materials as to the donor’s basis.
There is no statute of limitations in the Internal Revenue Code for purposes of determining the donee’s basis in a gifted or bequeathed asset. Thus, the IRS could challenge the basis of an asset for purposes of a sale, depreciation or other tax-related event until the statute of limitations expires for the applicable income tax – an event that could occur decades after the original gift or bequest. As a consequence, the donee must obtain and maintain tax basis supporting materials. And, even if an estate is not taxable, an appraisal of hard-to-value assets is necessary to determine the tax basis for the beneficiaries.
About the author
Julius H. Giarmarco, J.D., LL.M., is chair of Giarmarco, Mullins & Horton’s Trusts and Estates Practice Group in Troy, Michigan. Julius received his law degree from Wayne State University, and his master of laws from New York University. He is licensed to practice law in both Michigan and New York. Julius’ primary practice areas include estate planning, business succession planning, wealth transfer planning, and life insurance applications. Julius can be contacted by email or by phone at (248) 457-7200.