Erasing Built In Gain
August 2024
August is the time of year for back to school shopping. Supply lists include no. 2 pencils and erasers. With a pencil, a tentative answer can be erased.
The Code includes favorable income tax rules for the transfer of property at death. The most impactful provisions are with respect to the new basis under I.R.C. § 1014. Appreciated property transferred at death is generally subject to this rule and, as a result, any built in gain is erased.
New Basis Under I.R.C. § 1014
I.R.C. § 1014(a) provides a new basis for property acquired from a decedent.
The so called “new basis” or “step up basis” is generally equal to fair market value on the date of death. I.R.C. § 1014(a)(1).
This favorable rule effectively eliminates any built in gain that exists at death for property included in the gross estate. In other words, built in gain is erased.
The rule is not subject to any dollar limitation. The new basis benefits beneficiaries of all sizes of estates.
EXAMPLE: A owns various property interests that A purchased for $100,000. A’s cost basis is $100,000. I.R.C. § 1012. A dies when the fair market value of the property increases to $1 million. A’s will bequeaths all property to B. The property is considered acquired from a decedent and receives a step up of basis under I.R.C. § 1014(a). I.R.C. § 1014(b)(1). B’s adjusted basis in the property is $1 million. I.R.C. § 1014(a)(1). B thereafter sells the property to C for $1 million. B's recognizes gain of $0 (1,000,000 - 1,000,000 = 0). I.R.C. § 1001.
EXAMPLE: A owns various property interests that A purchased for $100,000. A’s cost basis is $100,000. I.R.C. § 1012. A dies when the fair market value of the property increases to $100 million. A’s will bequeaths all property to B. The property is considered acquired from a decedent and receives a step up of basis under I.R.C. § 1014(a). I.R.C. § 1014(b)(1). B’s adjusted basis in the property is $100 million. I.R.C. § 1014(a)(1). B thereafter sells the property to C for $100 million. B's recognizes gain of $0 (100,000,000 - 100,000,000 = 0). I.R.C. § 1001.
Exceptions exist. I.R.C. § 1014(a) does not apply to property that constitutes a right to receive an item of income in respect of a decedent under I.R.C. § 691. I.R.C. § 1014(c).
Additionally, I.R.C. § 1014(a) does not apply to certain circular gifts made close to death. I.R.C. § 1014(e).
Reporting of the new basis is made on Form 8971, Information Regarding Beneficiaries Acquiring Property From a Decedent, which is due thirty (30) days after the Form 706 is filed.
For more information, please consider the treatise for income tax issues in estate planning, “Income Taxation of Property Acquired from a Decedent.”