"The majority of people look at that $1.3 million and it seems like a fair amount of money," says Trenholm. "But with today's real estate, it's not unusual for a lot of people to have assets that reach that amount."
Trenholm uses this example, which he notes is simplistic for illustration purposes, to make his point:
Assume a child's widowed mother passes away. The child is her only heir and her home, worth $2 million, is the only asset in her estate. Under the current rules, her estate, the house, is not subject to federal estate tax since up to $2 million is exempt (the amount increases to $3.5 million in 2009). In addition, the child can sell the home for its full, stepped-up market value and owe no taxes on the proceeds.
Fast forward to 2010. The widow dies that year and leaves the same $2 million home to her only child. Since the estate tax is repealed, there is no worry in that area. However, if the child decides to sell the inherited home, the basis issue looms large. Rather than being able to use the $2 million market value as basis, the heir can only claim a basis of $1.3 million. That means a sale price of $2 million will leave the child with $700,000 in profit on which taxes are due, or a tax bill of $105,000.
So this heir would be better off if the transfer occurs before 2010, while the estate tax is still in place. Once it expires in 2010, and years thereafter if Congress repeals it altogether, this person and those in a similar situation will be dealing with the no-estate tax/larger-capital-gains tax predicament.
Property step-up dilemmas
Massey says the loss of full stepped-up basis is also going to require those receiving bequests, as well as the executors who manage the distributions, to more carefully consider what the heirs plan to do with the property.
This potential problem arises when estates: a) contain a combination of appreciated assets, such as real estate and stock holdings, and b) involve families with multiple heirs. For example:
- The oldest child is left the $3 million family home, with a carry-over basis of $300,000.
- The middle child gets Stock ABC, transferred with a basis of $500,000 and now worth $2 million.
- The youngest child gets Stock XYZ and Mom's basis of $100,000, although the stock is now worth $1.5 million.
With no estate tax, the combined $6.5 million estate owes Uncle Sam nothing. But the children, if they want to sell their inherited property, will each face a tax bill on the gain. The $1.3 million step-up provision could help at least one of them dramatically lower that tax cost.
Which asset, and heir, should get the benefit of the $1.3 million step-up? Or should it be divided among them? And who decides?