Carryover Basis Rules

With the repeal of the estate tax in 2010, assets transferred to your heirs will be subject to modified carryover basis rules, which could significantly impact the income tax potential on the assets. Although the repeal may be short-lived, safeguard your intentions and minimize the tax impact on your heirs by planning for your desired outcome.

Generally defined as the purchase price of the property minus certain adjustments, basis is used to calculate the amount of capital gains tax owed when an heir to an estate sells the property. Under the step-up provision, the basis of inherited property is increased to the fair market value (FMV) of the property on the date of death. This means that, when inherited property is sold, the stepped-up basis—sometimes referred to as the "fresh start basis"—is subtracted from the proceeds of the sale. Heirs then owe capital gains taxes only on the remaining amount.

Under carryover rules, inherited property receives a basis equal to the amount the deceased originally paid for the item. Depending on how much the property rose in value between the time of purchase by the deceased and the time of sale by the heir, the recipient of the property could owe much more in capital gains taxes under the carryover basis provision than under step-up basis rules.

In 2010, carryover basis applies to assets above $3 million inherited by the spouse of the deceased, and assets of more than $1.3 million inherited by anyone other than the spouse. Inheritances below these limits are subject to the step-up basis rules. Following the expiration of EGTRRA provisions on December 31, 2010, the step-up basis is scheduled to go back into effect, and estate tax will be assessed on property in excess of $1 million, with a maximum tax rate of 55%.

The carryover basis rules can create quite a dilemma for people trying to do estate planning under both pre-estate tax repeal and post-repeal rules. Contact us to review your estate plan to minimize your tax risks.