I cited in a previous article a long-standing rule in the tax code that authorizes an exceptionally beneficial advantage for people who sell inherited assets that have increased in value, such as stocks, real estate and works of art. This column discusses some tricky rules.
Inherited assets generally are stepped-up in basis from their original cost to their value on the date of the previous owner’s death. For heirs, that means forgiveness of capital gains taxes on pre-inheritance appreciation and, on subsequent sales, tax liability based only on post-inheritance appreciation.
Eye the Calendar
Buried in the federal tax code is a provision that forbids a step-up in basis for a transfer of appreciated property from a donor to a donee when the donee dies within a year and the property returns directly or indirectly to the donor or the donor's spouse. As a result, the basis remains whatever it was at the time the donor transferred the asset to the donee.
The prohibition is spelled out in Code Section 1014 (e), one small passage in the voluminous code. It contains the words that eighty-six a tax break for a donor who transfers property to a severely ailing donee on whose death the property then reverts back to the donor.
Without a Trace
The tax collectors lay down some meticulous rules for a sale of property left by someone who is a missing person. Here, an asset qualifies for a step-up to date of death value only if the heir receives property from someone who is considered to have died before the sale takes place. And, says the IRS, for a missing person to be declared dead, either a court has to rule that he’s dead or the assets (pursuant to a state statute) are, in effect, disposed of as though they were the property of a decedent.
What if a missing person’s last residence is in a state without a law that specifies the time when he’s presumed dead? He’s considered dead after seven years of continuous absence, unless death is established earlier.
The IRS provided guidance for such situations in Revenue Ruling 82-189. For example, let’s say a woman disappears while on a flight over the Andes in early 2016. The search party is unable to find her or the plane. Her husband is appointed conservator of her estate and is authorized to sell real estate owned by her that had cost $40,000 originally and was valued at $400,000 at the time she vanished. The husband sells the property before the close of 2016 and files a final joint return for that year. The return assigns a basis of $400,000 for the property.
The couple resides in a state with a presumption of death statute. This provides that a person is presumed dead if the individual is absent from the last known place of domicile for five continuous years and the absence isn’t satisfactorily explained after diligent search and inquiry. Death is presumed to occur at the end of the five-year period unless there’s evidence establishing that death occurred earlier.
The verdict: The law in the wife’s state doesn’t presume that she’s dead at the time of the sale. Therefore, there’s no step-up for the realty. To figure tax on the transaction, measure the sale's price of $400,000 against the cost of $40,000.
To sidestep the statute and gain the benefit of the step-up, all the husband has to do is delay the sale until the presumption of death takes effect.
Additional articles. A reminder for accountants who would welcome advice on how to alert clients to tactics that trim taxes for this year and even give a head start for next year: Delve into the archive of my articles (more than 250 and counting).
Attorney and author Julian Block is frequently quoted in the New York Times, Wall Street Journal, and the Washington Post. He has been cited as “a leading tax professional” (New York Times), an “accomplished writer on taxes...