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Vacuum Left Where Certainty Once Was

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By Lowell L. Kalapa

Okay, okay, we heard from readers who have been following the new federal tax changes more closely and they report that there is a provision for adjusting the basis of property which passed from a decedent to an estate’s beneficiary. However, the adjustment of the basis or value will be limited to only the first $1.3 million.
The new law also provides that the cap of $1.3 million may be increased if there are unused capital losses, net operating losses, and certain “built-in” losses. Further, the adjustment of basis will also apply to assets transferred to a surviving spouse by another $3 million. Thus, the basis of property transferred to a surviving spouse can be as much as $4.3 million. When the surviving spouse passes on, another $1.3 million worth of property can have its basis adjusted.
Add to that, the fact that the new law also extends the $250,000 exclusion of gain on the sale of a principal residence to estates and heirs of estates. Thus, if a beneficiary inherits the principal residence of the decedent, the adjustment of basis or stepped up basis may not have to be elected if the difference between the decedent’s interest and sale price of the residence is less than $250,000 as the exclusion would preclude that sale from taxation.
As noted in an earlier column, these new rules on a limited application of the stepped up basis come into effect after the federal estate tax is repealed in the year 2010. While some argue that those caps will essentially take care of the bulk of estates, that argument fails to recognize that $1.3 million by the year 2010 may not represent a lot of property.
It is anyone’s guess how much property will appreciate over the next ten years. Just tak a look at where the stock market was ten years ago and where it was in 1999. While those caps will be adjusted for inflation after they go into effect in the year 2010, who knows whether those amounts will be adequate to protect what might be considered a modest estate.
And what happens to property that exceeds the adjustment cap of $1.3 million? The executor or personal representative of the estate has to make a decision as to which property will have the advantage to adjust its basis to fair market value at the time of the decedent’s death. All other property which does not qualify under the $1.3 million cap or the $3 million spousal transfer will take on the lesser of the decedent’s interest in the property or the fair market value at the time of death.
Since property which has been held for any amount of time will probably be that of the decedent’s interest. Problem is how many people are good record keepers, let alone prudent enough to either write a will or do estate planning. Ask yourself if you know how much you paid for that share of AT&T or for that heirloom koa rocker?
There is no doubt that Congress and tax officials will have to revisit this provision of the new federal tax law. This is not the first time the stepped up basis rule or the adjustment of basis of inherited property has been changed or altered. There were two previous times, once in the 1920’s and again in the 1970’s, when Congress tinkered with the basis rules and both times those tinkerings were subsequently repealed. Both repeals were undertaken because the newly enacted rules were an administrative nightmare, much as the new rules adopted in this year’s legislation appear to be.
Not only will it be difficult to determine which pieces of property will benefit from the limited stepped up basis application, but it will also be difficult to determine what the decedent’s original interest in the property was. Instead of simplifying the whole “death tax” experience, federal lawmakers have made a mess of the federal estate tax situation.
Here at the state level, similar challenges will be encountered by state lawmakers. Will state lawmakers go along with the changes made by Congress or will they write their own rules for state tax purposes? And what about a state inheritance tax? There is no doubt that lawmakers won’t want to give up the $20 million that is currently raised by the state’s inheritance tax which is a piggyback on the federal estate tax.
While the casual observer/taxpayer may be hailing the actions take by Congress, the real devil is in the details. Instead of resolving a knotty issue of estate taxes by repealing the law, federal lawmakers have actually created havoc that will take years to resolve.

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