The income tax concept of “basis” figures prominently in estate planning.
On the sale (or final disposition) of an asset, the seller’s basis is used to calculate whether the seller has a gain or loss for income taxes.
A capital gains tax occurs when an asset is sold for more than its basis; such as when an appreciated asset is sold or when a depreciated asset is sold (or disposed of) for more than its remaining tax basis. Minimizing these capital gains taxes is an important estate planning goal.
How basis is determined varies as follows: (1) Purchased assets have an initial cost (purchase price) basis; which may get adjusted up for capital improvements and down for income tax depreciation; (2) gifted assets carry over the transferor’s basis; and (3) inherited assets, other than retirement assets, receive a new basis equal to the appraised date of death value (if higher, it is called a “stepped-up” basis) because they were included in the deceased person’s estate for federal estate tax purposes, regardless of whether an estate tax was due.
With the estate tax thresholds now at $5,250,000 and $10,500,000 for single and married persons, respectively, the estate tax rarely ever bites but is always relevant for basis purposes (except for retirement assets).
For example, in 1970 a father buys his home for $50,000; the father’s initial basis is $50,000.
In, 1975, the father makes $20,000 in improvements. He gets a new basis of $70,000.
In 2012, he dies and his daughter inherits the home, now appraised at $250,000. Daughter’s new basis is $250,000; a $180,000 increase.
Married couples have tax opportunities both for the surviving spouse and for the couple’s subsequent beneficiaries.
At the first spouse’s death, the deceased spouse’s separate property and all the couple’s community property assets get a new basis.
All assets owned as community property receive a full basis adjustment (even though half belongs to the surviving spouse).
At the second spouse’s death, the first deceased spouse’s separate property assets may sometimes get a second step up in basis that typically benefits the children. That is, provided such assets are includable in the second spouse’s estate for federal estate tax purposes.
That can be either because these assets were gifted directly to the surviving spouse (either outright or to the surviving spouse’s revocable trust) or because the decedent’s assets were held in a further marital trust.
A marital trust, to qualify as such, must provide that the surviving spouse receives all the income from the assets, during her lifetime. It may also provide for distributions of principal to the surviving spouse. While alive, the surviving spouse must be the sole beneficiary. At her death, the remaining assets typically pass to the first spouse’s children.
Irrevocable trusts that were previously established at the death of the first spouse with the deceased spouse’s assets, as so-called bypass (aka, “credit shelter”) trust may sometimes qualify as marital trusts.
If the irrevocable trust satisfies the requirements to be a marital trust, a special so-called QTIP election can be made (this year) to allow the trust assets to be included in the surviving spouse’s estate for estate tax purposes and to get a new (and hopefully higher) basis at the surviving spouse’s death.
For these reasons, many estate planners now draft any irrevocable trust established at the death of the first spouse to meet the marital trust requirements.
The surviving spouse can then make the QTIP election, presuming the surviving spouse’s enlarged estate is not expected to be so large as to suffer from an estate tax that would exceed the income tax benefits.
Dennis A. Fordham, attorney (LL.M. tax studies), is a State Bar Certified Specialist in Estate Planning, Probate and Trust Law. His office is at 870 S. Main St., Lakeport, California. Fordham can be reached by e-mail at This email address is being protected from spambots. You need JavaScript enabled to view it. or by phone at 707-263-3235. Visit his Web site at www.dennisfordhamlaw.com .