In 2010, there is no federal estate tax, but we have new capital gains tax laws known as the modified carryover basis rules. (After 2010, prior estate tax and capital gains tax laws will take effect again.) In short, an asset owned by a decedent who dies during 2010 and received from the decedent can end up with a step-up in basis, which means the recipient of the asset receives a capital gains tax advantage. All of the appreciation in value from the time of purchase through the decedent’s date-of-death can end up escaping any capital gains tax when the asset receives a step-up in basis, so this issue can be especially significant for real estate that was owned for many years before someone’s death in 2010.
(1) What are the mechanics on how to obtain a step-up in basis? The Executor of the decedent’s estate can elect to increase the basis of certain assets by up to $1,300,000, or up to $4,300,000 if the decedent was married. The IRS is working on a new form to replace the Federal Estate Tax Return, and the due date would be when income tax returns are due. If the form isn’t filed on a timely basis, the recipient of the assets from the decedent could lose out on the step-up in basis. If you are in charge of the estate of someone who died during 2010, or in charge of a trust established
(2) Are assets in a revocable trust eligible for a step-up in basis? The answer appears to be yes, but there may be a catch, in that an income tax election may be required to treat the trust as a “qualified revocable trust," which is a consolidation of the trust with the decedent’s estate for income tax purposes.
(3) Is a life estate eligible for a step-up in basis? In my opinion, Internal Revenue Code Section 1022 can be interpreted to allow a reserved life estate to be eligible for a step-up in basis. (Note, however, that other tax specialists disagree with my position.)
(4) Are any reserved powers of appointment eligible for a step-up in basis? A power of appointment is a power to make changes to who inherits an asset, as well as when and how. Internal Revenue Code Section 1022 explicitly states that a power of appointment is not entitled to a step-up in basis, so it may appear that there is no chance for a power of appointment to cause entitlement to a step-up in basis, but my opinion is that a power of appointment that was reserved in a trust (as opposed to being given to someone else) is eligible for a step-up in basis.
Congress has talked and talked about making changes to this tax law, and some of those proposals have been to change the law retroactively to the beginning of 2010, or to give taxpayers a choice as to what law they prefer. The bottom line is that if you inherited anything from somebody who died during 2010, you should consult with a tax specialist (lawyer or CPA) before filing your income tax returns in 2011.