Basis Consistency Rules When Administering an Estate or Inheriting Property
When it comes to tax law changes and estate planning, the substantial increases to the gift and estate tax exemptions under the Tax Cuts and Jobs Act are getting the most attention these days. But a tax law change enacted in 2015 also warrants attention.
The 2015 basis consistency change affects the value of inherited property. It generally prohibits the income tax basis of inherited property from exceeding the property’s fair market value (FMV) for estate tax purposes.
Why does this matter? It prevents beneficiaries from arguing that an estate undervalued a property. This prevents a beneficiary from claiming a higher basis for income tax purposes. The higher the basis, the lower the taxable gain on any subsequent sale of the property.
Before the 2015 change, estates and their beneficiaries had conflicting incentives when it came to the valuation of a deceased person’s property. Executors had an incentive to value property as low as possible to minimize estate taxes. Beneficiaries had an incentive to value property as high as possible to minimize capital gains, should they sell the property.
The 2015 law requires consistency between a property’s basis reflected on an estate tax return and the basis used to calculate gain when it’s sold by the person who inherits it. The basis of property in the hands of a beneficiary may not exceed its value as finally determined for estate tax purposes.
Generally, a property’s value is finally determined under one of these circumstances:
- The IRS doesn’t challenge the value reported on a federal estate tax return before the limitations period expires.
- The IRS determines its value and the executor doesn’t challenge it before the limitations period expires.
- A court order or agreement.
But the basis consistency rule isn’t a factor in all situations. The rule doesn’t apply to property unless its inclusion in the deceased’s estate increased the liability for estate taxes. So, for example, the rule doesn’t apply if the value of the deceased’s estate is less than his or her unused exemption amount.
Watch out for penalties
The 2015 law also requires estates to share information about the value of inherited property to the IRS and the person who inherits it. Estates that fail to comply with these reporting requirements are subject to failure-to-file penalties.
Beneficiaries who claim an excessive basis on their income tax returns are subject to accuracy-related penalties on any resulting understatements of tax. Contact us if you’re responsible for administering an estate or if you expect to inherit property from someone whose estate will be liable for estate tax. We can help you comply with the basis consistency rules and avoid penalties.