Inherited Property Information

Losing a loved one is a difficult thing. But after the funeral the heirs must go on.  That generally involves settling the estate and distributing the assets of the deceased.  Whether you are the one in charge or a beneficiary, there is information that must be passed along with the assets that are distributed. Those assets carry with them a special number known as the basis of the asset.  Basis in another name for cost, although in this case it does not necessarily reflect just the purchase price of the item. While this may not seem important when you receive the property, it may be important at some time in the future.  However, it is much easier to find the basis at the time of death than to search for it later.

In 2010, the estate tax rules changed dramatically.  We went from paying estate tax on estates with assets in excess of $3.5 million dollars at the rate of 46% to not paying estate tax on any amount.  This tax freedom for estates is only scheduled to last for one year.  But this short term change adds to the confusion of what information is necessary to pass along to the beneficiaries. This estate tax freedom caused a corresponding change in calculating the basis of the assets.  In 2011, the basis calculation rules return to the pre-2010 rules.  If this isn’t confusing enough, remember that Congress has the power to change these rules and may do so.  But until then, it is important to know what the heirs need to know.

If you are the recipient of inherited assets you will be asked what your basis in the asset is at the time of disposition of the property.  That disposition could be by sale, trade, or gifting of the property.  You may even need to know your basis earlier if the property is used in a business or as rental property for depreciation purposes.

To determine this magic number we need to begin with the date of death of your loved one.   If the death occurred prior to 2010, the general principle is that the basis of inherited property is the fair market value of the property on the day of death.  That means that most items you receive will have a cost (basis) equal to what the item is worth when your loved one died.  If Aunt Sally died on June 1, 2009, and owned AT&T stock at the time of death, the average cost of the stock traded on the date of death ($24.91 per share) will be the basis.  If the stock is not being traded on that day, an average of the closest day before and after the date of death is used. 

Certain items do not receive a step-up in basis.  Retirement funds such as annuities, traditional IRAs, and company pension funds keep the same basis that the decedent had.  That generally means that these items will be taxable to the heirs in the same manner that they would have been to the decedent.  Special rules exist for certain installment sales.  When economic conditions cause the value of the estate to drop within six months after the date of death special basis calculations may be available.

The year 2010 ushered in the year of no estate tax but also change the rules for calculating basis of inherited assets.  This will mean additional work for the personal representative.  The general rule for basis of inherited property in 2010 is the lower of the cost of the asset to the decedent or the fair market value on the date of death.  If Aunt Sally died on June 1, 2010, the basis of her AT&T stock would be the lower of her cost which is generally her purchase price or the value of the stock on the day she died.
The cost of the inherited items can be difficult to find if the decedent did not keep good records.  The records may be there, but if the personal representative does not know what to look for or what is important, the records may be destroyed.  It is extremely important not to destroy the decedent’s files until a successful search has ended.

Here are some suggestions for those who may be the recipients of inherited property either in 2010 or any other time.

• Ask the personal representative for the basis of the asset received in the settlement.
• If the information is not available, make suggestion to the personal representative about how that information may be attained.
• If you are a prospective personal representative, you could review the assets included in the estate before the individual dies.  Knowing where records are before death would make the job easier.
• At the time of death an inventory of all the assets should be made.  If this is 2010, the fair market value of these assets should be obtained.  The best way to obtain a fair market value is through an appraisal by a reputable appraiser.  This will cost money but is the most effective way to evaluate the assets.  If that is not possible, a market analysis or blue book value is better than no value.  Also, the internet may be useful in finding values.
• For 2010, it will be important to secure the cost of the assets to the decedent.  If the assets are held by a broker, the broker may have the necessary cost values.  If the assets were in the possession of the decedent, a careful search of the records is necessary.  The decedent may have had a safety deposit box, a safe, or a file cabinet to house the records.  Investments may be the easiest records to track.  Real estate which has been improved may be more difficult.  To begin the search for the cost of real estate, find the original deed to the property.  From that point, look for any records showing purchases of improvements. 
• If records are not easily attainable, interviewing parties who may be aware of the improvements or shared in purchases may be a helpful source.
• If property was received because of a prior death, the value generally starts with that death.  Property that was received by gift, has a basis equal to the cost basis of the person who gifted the property.  Old gift tax returns, Forms 709, may contain the information.

There is one exception.  Appreciated property in the estate during 2010 may qualify to be stepped up to fair market value by $1.3 million plus certain other tax attributes.  This amount is increased by $3 million if the spouse is the heir.  It is up to the personal representative to allocate the exemption among the assets.

The basis of assets is important in determining the gain or loss at the time of disposition.  If you are not able to obtain the basis, the IRS takes the position that the basis is zero.  That puts the liability for the tax on the shoulders of the holder of the property.