Basis in the World of Tax: Property, Part 2

Tax Law and News tax settlement cases

Thanks for tuning back into my series on basis. We covered basis of converted property, property acquired by gift and property acquired incident to divorce. Here, I’ll talk about basis of inherited property.

Inherited Property

Tax basis of property acquired by inheritance is generally the fair market value at the date of death. However, certain alternative basis amounts may be used at the election of the estate of the decedent.

Basis in property held in joint tenancy with a right of survivorship or as tenants by the entirety, by unmarried owners, generally depends upon the amount invested by each joint tenant.

Here are some examples to help explain the laws around inherited property:

  • Russell and Kari are not married and purchase a condo for $100,000, which they own as joint tenants with right of survivorship. Russell contributed $30,000 and Kari $70,000 toward the purchase. When Kari died, the property was worth $200,000; $140,000, which is 70 percent of the fair market value, is included in her estate. Russell’s basis in the property is $170,000 – his original contribution of $30,000 plus Kari’s $140,000 fair market value.
  • Consider the same facts as above, except that Russell and Kari rented the property. Over the years, $25,000 of depreciation was allowed. If Russell and Kari are each entitled to half of the income from the property under local law, Russell’s basis would be reduced by $12,500, which is half the accumulated depreciation, to $157,500.

If the joint tenants are spouses in a separate property state, then the property is a qualified joint interest, and it does not matter who paid for it. Half of the fair market value is included in the gross estate of the first spouse to die. The surviving spouse’s basis in the property is half of the original cost, regardless of the amount contributed, plus half of the fair market value at date of death.

For example, Russell owned a home jointly with his wife Kari. The home had an adjusted basis of $50,000 and a fair market value of $200,000 at the date of Russell’s death. The new basis for Kari is half of $50,000 plus half of $200,000, for a total of $125,000.

If the property is held jointly as tenants in common or tenants by the entirety, you need to look at state law to determine if there is full step-up or only half step-up in basis. Generally, in community property states – Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington and Wisconsin—each spouse is considered to own half of the community property. When either spouse dies, the basis to the surviving spouse is generally the fair market value at the date of death for the entire property. The surviving spouse gets full step-up to fair market value. However, to get full step-up in basis, at least half of the community property interest must be includible in the decedent’s estate, even if there is no filing requirement.

For example, Russell and his spouse live in Texas. The fair market value of the home was $200,000 at the time of Kari’s death, and half was included in her estate. The new basis to Russell is $200,000.

When it comes to rental property in community property states, married taxpayers will receive full step-up. Depreciation starts over with the new fair market value. If there was any amortization for points, closing costs, etc., then the amortization continues until the property is refinanced with a different lender. At that point, you can write off the remaining amortization. Rental property in a community property state owned by individuals who are not married to each other receives half step-up, and depreciation starts over for that half. The other half continues as previously. This is the same treatment in separate property states for married couples.

To determine the fair market value at the date of death, use property tax statements for real property if no appraisal was done, or ask a real estate agent to run comparables. You can also use brokerage statements for stocks and bonds for the date of death; the brokerage should provide fair market value at date of death. If fair market value was not provided by the brokerage or the executor, many websites are available to find basis. If the date of death is on a weekend or another non-trading day, then take the average of the high and low of the day preceding, and the day after the date of death, and average those. If property other than stock (real estate, for example) is sold within a short time period after the date of death, the sales price is likely the fair market value.

If a required Form 706, United States Estate (and Generation-Skipping Transfer) Tax Return, is never filed, the basis of assets required to be reported will be zero for the heirs. If assets are omitted from a required Form 706 and the statute of limitations has expired, the basis of the omitted property is zero to the heirs. If assets were omitted from a required Form 706 and the statute is still open, the estate may report those assets on an amended Form 706. The heirs will get basis in the amount of the final estate tax value.

I’ll be back with another article on property basis in my basis series. Till next time!