What to Look Out For
Whether an individual is involved in a decedent’s affairs as an executor or beneficiary, the new basis consistency rule and corresponding reporting requirements should not be overlooked. Depending on the number of beneficiaries of an estate, the penalties for failure to file correct information returns of $250 per statement can accumulate to a maximum penalty of $3,000,000. On the beneficiary side, accuracy-related penalties on underpayments of tax will apply if a taxpayer reports a higher basis than the estate tax value, according to the new rules.
When you inherit property from a decedent, determining your basis in the property (i.e., the amount used to determine your gain at the time of sale) is often an afterthought. It is not until the property is later sold that the recipient realizes they need their basis in the inherited property to determine their taxable gain.
In general, when property is received from a decedent, the beneficiary’s basis is equal to the fair market value of the property at the date of the decedent’s death. As a result, beneficiaries often get a “step-up” from the decedent’s basis. This, of course, is presuming the property appreciated in value during the time the decedent held the property.
The reason for the “step-up” can be traced to the estate tax reporting requirements. According to the Internal Revenue Code (IRC), a decedent’s gross estate includes the fair market value of property owned by the decedent on their date of death. Ignoring any exemptions that may apply, the IRC is effectively taxing the decedent on the property as if it were sold for fair market value on that date. If the beneficiaries didn’t receive a “step-up” in basis to the fair market value, the IRC would effectively be taxing the same gain twice: once through estate tax and then again through income tax when the property is later sold by the beneficiary.
While a low value is desirable because it will minimize the estate tax, a higher value results in a higher basis for the beneficiary which, in turn, leads to less gain upon the future sale of the inherited property. Prior to new basis consistency rules being issued, the IRS had no way to track a beneficiary’s basis in inherited property. Beneficiaries could claim the fair market value of an asset on the date of death was actually greater than the value used for estate tax purposes with very little likelihood that the IRS would ever be able to discover this. As a result, the new basis consistency rule and related reporting requirements have been issued.
Basis Consistency Rule
In general, the new basis consistency rule states that a beneficiary’s basis in property acquired from a decedent will be no higher than the finally determined estate tax value or, if the final value has not been determined, the value provided in a statement to the decedent’s recipients.
An exception to this rule exists when the property received by the beneficiary does not increase the estate tax liability. Examples include:
- Property qualifying for a marital deduction
- Property qualifying for a charitable deduction
- When the gross estate is under the exclusion amount
- When an estate return is only being filed to elect portability
This new rule applies to property with respect to which an estate tax return is filed after July 30, 2015.
Information Reporting Requirements
To enforce the new basis consistency rule, the IRS is now requiring the executor of any estate required to file an estate tax return to furnish to both the IRS and the person acquiring property included in the decedent’s gross estate “a statement identifying the value of each interest in such property as reported on such return and such other information with respect to such interest as the Secretary may prescribe.”
This information is required to be reported on Form 8971 and Schedule A, which were finalized by the IRS on January 29, 2016.
The instructions to Form 8971 state that estates that file returns “for the sole purpose of making an allocation or election respecting the generation-skipping transfer tax or solely to elect portability of the deceased spousal exclusion amount” are not subject to reporting requirements.
Statements are due no later than the earlier of:
- 30 days after Form 706 is required to be filed (including extensions), or
- 30 days after Form 706 is filed.
Due to the availability of the forms, the IRS has delayed the filing due date until February 29, 2016, at the earliest for any statements that would otherwise be due before that date.
Failure to file the basis statement going forward will be equivalent to failing to file an “information return” such as a 1099, resulting in penalties of $250 per statement.