Estate and Capital Gain Taxes in 2010

Scott Saunders
March 4, 2010 — 1,140 views  
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Beginning January 1, 2010, the 45% estate tax on estates over $3.5 million for individuals or $7 million for married couples is eliminated (temporarily). However, the estate tax returns in 2011 —at a higher 55% tax rate and to smaller estates.

NO ESTATE TAXES IN 2010 BUT HIGHER CAPITAL GAIN TAX CONSEQUNECES

Along with no estate taxes in 2010, the familiar “step-up” in basis on property owned by a decedent at death, is now limited to $1.3 million, which may be allocated among thedecedent’s assets. Given the limited basis step-up, the heirs of a decedent dying in 2010 might owe capital gain taxes based upon the decedent’s adjusted basis at the time of the decedent’s death. If the heir cannot establish evidence of that basis, then the IRS dictates that the heir’s basis is zero. In this regard, things might get more challenging as individuals who inherit assets will have to prove the basis of assets which can be very difficult as splits, mergers, stock dividends might render tracking this accurately a nightmare. Essentially, this may leave many heirs of estates that fall between $1.3 million through $3.5 million in 2010 in the unfortunate position of generally paying more in capital gain taxes than would have been owed in estate taxes. According to the Reuters article, Estate Tax Seen Bringing Chaos, up to 70,000 heirs could face higher taxes by the elimination of estate taxes in 2010.

The Economic Growth and Tax Relief Reconciliation Act of 2001 (“2001 Act”) temporarily repealed the estate tax and generation-skipping transfer tax for estates of individuals dying in 2010. However, the current transfer tax rules are in a state of flux as a result of changes made by the 2001 Act that have been gradually implemented. The 2001 Act contained a so-called “sunset rule” under which the pre-2001 Act rules return after 2010 unless Congress provides otherwise at some future time. The 2001 Act also changed the unified system so that the gift tax exemption amount remained at $1 million for all years after 2001 and the gift tax is not being repealed during 2010 as is the estate tax. Under the “sunset rule,” the exemption will be $1 million for both estate and gift tax purposes in 2011. In 2010, there is no estate tax and the top gift tax rate is 35%. The top estate and gift tax rate reverts to 55% in 2011. For 2010, the basis rules for inherited property are similar to the gift tax rules.

POSSIBLE WINNERS IN 2010

The heirs of individuals dying in 2010 with very large estates will save a substantial amount of transfer tax. While they may also be exposed to some income tax under the modified carryover basis regime, the transfer tax savings would more than offset the increased income tax costs.

POSSIBLE LOSERS IN 2010

Heirs of many smaller estates could come out worse as the step-up in basis is removed. While these individuals won't face transfer tax costs, they could face significantly higher income and capital gain tax costs. Whether a winner or a loser as discussed above, the potential to defer capital gain taxes with a 1031 exchange remains a viable option for heirs inheriting appreciated property under the current transfer tax regime.

Note: This brief overview was prepared in March, 2010 and many tax advisors expect tax legislation to be enacted sometime in 2010 to address these issues.

Scott Saunders

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Scott R. Saunders, Senior Vice President with Asset Preservation, Inc. Scott has an extensive background in Internal Revenue Code §1031 tax deferred exchanges, having been involved in structuring and overseeing over 50,000 transactions during his sixteen years in the exchange industry. Asset Preservation, a subsidiary of Stewart Title Company, is a leading national IRC §1031 "Qualified Intermediary" and has successfully completed over 130,000 1031 exchanges throughout the nation.