Congress did a good thing when they made the tax law that changes the tax basis of stocks, bonds, real estate and personal property to the fair market value at the date of death.
Here is an example of the benefits of that law. Let’s call the decedent Leo. He died recently and his children inherit what he left. He had a rental house in California that had a tax basis (like his cost) of about $225,000 with $40,000 allocated to land.
The depreciation expense claimed on his personal income tax returns was figured on the building of about $185,000. At his death the fair market value of the rental is about $1.2 million. That will give a lot more depreciation expense and save a lot of income tax for his children.
The children (adults over 30 years old) plan to sell the rental when the current lease expires next year. The selling price will be offset by the new tax basis — $1.2 million less whatever depreciation expense is claimed from date of death to sale date. That means most of the sales proceeds will be tax free or a small gain to be taxed as long term capital gain (with some possible depreciation recapture income).
The prior depreciation expense claimed by Leo on his personal income tax returns will be “wiped out” and forgotten. It escapes any income tax. The original cost of the rental is replaced by the tax basis at death. Almost $1 million of gain he would have paid tax on if it was sold during his lifetime is gone-not taxed at all. Holding the rental until after his death saved a lot of taxes.
We see a few tax returns the individuals prepared that did not use the new tax basis at death, but just continued the old original cost. That can be a big mistake and cause a lot of tax to be paid that is wrong-is not owed.
The general rule is all tax returns are “open” for IRS to audit or the taxpayer to amend for three years.
If you know of a situation where the wrong tax basis was used — was not changed to the value at death, — maybe it is advisable to get amended returns prepared.
The tax basis “step up” at death does not apply to IRAs or annuities and a few other items.
If Leo’s children did not use the correct tax basis, they might have paid a taxes to IRS and California on the sale of the rental that was not owed.
Did you hear? “We’ve heard of one large company that has just begun a program to reduce staff through attrition. It hired a new vice president, three assistants and five secretaries to manage it. Sounds like the government, doesn’t it?”
John Bullis is a certified public accountant, personal financial specialist and certified senior adviser who has served Carson City for 45 years. He is founder emeritus of Bullis and Company CPAs.