How the Basis Step Up Rules Work in 2010

By Debra Sawyer, CPA, CFP®, ChFC®, CLU®
May 17, 2010

Taxpayers who die during 2010 will not owe an estate tax as it has been repealed for the year 2010 under the Economic Growth and Tax Relief Reconciliation Act of 2001 (2001 Tax Act) signed by President Bush. However, there is a downside to no estate tax which is a carryover basis system. For all years except 2010, the heirs receive the estate assets with a basis equal to fair market value at date of death. However, under the carryover basis system in place for 2010, the deceased taxpayer’s basis carries over to the heir (limited to fair market value at death). In addition, the executor has the ability to step up the basis by $1.3 million on assets passing to any heir plus an additional $3 million of basis step up on assets passing directly to the surviving spouse.
 
The following four examples illustrate how the basis step up rules work for taxpayers who die during 2010. The executor in each example will elect to allocate as much basis step up as possible to the assets mentioned in the fact pattern.
 
Example #1 - Bethany died during 2010 with $4 million of stock in a large publicly traded company which she bought 6 years ago for $750,000. Bethany’s will provides that her son Rob inherits the stock at her death. Rob’s basis will be the $750,000 of carryover basis plus the $1.3 million of step up in basis for a total of $2,050,000.
 
Example #2 - Carl died during 2010 with $6 million of stock in a closely held family business with a $1 million basis.  Carl’s will provides that his wife Susan will inherit this asset.  Susan’s basis will be the $1 million carryover basis plus the $1.3 million of basis step up allowed for any heir and the $3 million additional spousal basis step up for a total of $5.3 million. Note, if the business had only been worth $5 million, then Susan’s basis would have been limited to $5 million, but the executor could have allocated the additional $300,000 to another asset.
 
Example #3 – Phil and Elsa live in a community property state. They bought their home for $800,000 in 1995. Elsa died during 2010 when their home was worth $1.9 million. Elsa’s will provides that all of her assets pass to Phil. Since they live in a community property state, it is possible to step-up the entire property to fair market value at death. Elsa’s executor would allocate $1.1 million of basis step up to the $800,000 of carryover basis to bring Phil’s basis up to $1.9 million. If Phil and Elsa had lived in a separate property state, then the executor would have only been able to step up Elsa’s 50% to $950,000. Phil’s $400,000 basis on his original 50% would carryover for a total basis of $1,350,000.
 
Example #4 – Ken retired in Florida and bought a penthouse suite overlooking the ocean for $2 million. Due to the drop in the real estate market, his suite was only worth $700,000 at the time of his death in 2010. Ken’s will left the suite to his sister Betty.  Due to the limitation on fair market value at the time of death, Betty will have a basis of $700,000 in the penthouse suite.