Q: My parents deeded land to me and my siblings 10 years ago, keeping a life estate in the property reserved for themselves. Our last surviving parent died in November of 2009. We're trying to figure out how we will be taxed when we sell this land. I've had conflicting answers about what we should use as our cost basis. Some tax accountants have said we must use the original purchase price, and others say we can use the value of the property last November when our mother died. Which is correct? -- KF via email
A: Your cost basis is the market value of the property at the time of your mother's death last November.
In tax jargon, your cost basis for this property is 'stepped-up' to its market value.This means that if the land was worth $5 million last November -- why not use a nice fat hypothetical number? -- you can sell it for $5 million without incurring any capital gains tax.
By contrast, if you had to use the original purchase price as your cost basis, you'd owe a tax on the difference between your sale price and what your parents originally paid for the land. So if they'd bought it for $100,000 and you sold it for $5 million, your taxable profit would be $4.9 million.
Quite a difference, isn't it?
But as I'll explain in a moment, people who inherit assets from someone who dies in 2010 can't use the above example as a guide.
That's because the rule in question is based on the relationship between two different taxes. One is the capital gains tax, which is the tax on your profit when you sell an asset that has appreciated in value since you acquired it. The other is the federal estate tax, which is the tax levied on assets that you bequeath to your survivors -- and as of January 1, we don't have a federal estate tax.
The longstanding rule is that heirs get a 'stepped-up' cost basis on assets that are subject to estate tax. This is true even if the estate in question is actually too small to owe any estate tax.
The practical result is that people have long enjoyed a stepped-up cost basis on most inherited capital assets. (I say 'most' because of course there are important exceptions. You never get a step-up on any asset that is inside a tax-deferred retirement account, for example.)
Because your mother kept a retained life estate in this property, 100% of its value is included in her taxable estate. Therefore you inherited it at its stepped-up cost basis. As I explained in an earlier post, even tax professionals sometimes get this wrong; that's why you've heard conflicting advice about it.
But Congress let the estate tax law expire on December 31, 2009. Remember, you only get a step-up on inherited capital assets that are subject to estate tax. Because there is no federal estate tax at the moment, there's no step-up on inherited capital assets.
The good news for most people is that there is an exemption. "Each estate is entitled to a $1.3 million aggregate basis step-up, and a $3 million spousal step-up," says Bernard A. Krooks, a New York estate and elder law attorney.
A: Your cost basis is the market value of the property at the time of your mother's death last November.
In tax jargon, your cost basis for this property is 'stepped-up' to its market value.This means that if the land was worth $5 million last November -- why not use a nice fat hypothetical number? -- you can sell it for $5 million without incurring any capital gains tax.
By contrast, if you had to use the original purchase price as your cost basis, you'd owe a tax on the difference between your sale price and what your parents originally paid for the land. So if they'd bought it for $100,000 and you sold it for $5 million, your taxable profit would be $4.9 million.
Quite a difference, isn't it?
But as I'll explain in a moment, people who inherit assets from someone who dies in 2010 can't use the above example as a guide.
That's because the rule in question is based on the relationship between two different taxes. One is the capital gains tax, which is the tax on your profit when you sell an asset that has appreciated in value since you acquired it. The other is the federal estate tax, which is the tax levied on assets that you bequeath to your survivors -- and as of January 1, we don't have a federal estate tax.
The longstanding rule is that heirs get a 'stepped-up' cost basis on assets that are subject to estate tax. This is true even if the estate in question is actually too small to owe any estate tax.
The practical result is that people have long enjoyed a stepped-up cost basis on most inherited capital assets. (I say 'most' because of course there are important exceptions. You never get a step-up on any asset that is inside a tax-deferred retirement account, for example.)
Because your mother kept a retained life estate in this property, 100% of its value is included in her taxable estate. Therefore you inherited it at its stepped-up cost basis. As I explained in an earlier post, even tax professionals sometimes get this wrong; that's why you've heard conflicting advice about it.
But Congress let the estate tax law expire on December 31, 2009. Remember, you only get a step-up on inherited capital assets that are subject to estate tax. Because there is no federal estate tax at the moment, there's no step-up on inherited capital assets.
The good news for most people is that there is an exemption. "Each estate is entitled to a $1.3 million aggregate basis step-up, and a $3 million spousal step-up," says Bernard A. Krooks, a New York estate and elder law attorney.
This means that a person who isn't married can still leave $1.3 million in assets that will qualify for the step-up. Someone who is married can leave $1.3 million of assets that get the step-up, plus an additional $3 million of assets to his or her spouse that will qualify for the step-up.
But the above exemptions don't apply to property in which the decedent had retained a life estate. If your mother had died last week, you wouldn't get the step-up on your inheritance. The current situation is temporary, however. There's little doubt that the federal estate tax will be reinstated, probably later this year. When that happens the unlimited step-up will return.
But the above exemptions don't apply to property in which the decedent had retained a life estate. If your mother had died last week, you wouldn't get the step-up on your inheritance. The current situation is temporary, however. There's little doubt that the federal estate tax will be reinstated, probably later this year. When that happens the unlimited step-up will return.
Please send your questions to Lynn@LynnBrennersFamilyFinance.com. I'm sorry I can't respond personally to every email. Questions are only addressed online.(c) Lynn Brenner, All Rights Reserved
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