Analyzing the Carryover Basis Election Impact 2010 Estates

Analyzing the Carryover Basis Election Impact 2010 Estates
Presented by: Robert S. Keebler, CPA, MST Keebler & Associates, LLP 420 S. Washington St. Green Bay, WI 54301 Phone: (920) 593-1701 robert.keebler@keeblerandassociates.com Circular 230 Disclosure: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this communication, including attachments, was not written to be used and cannot be used for the purpose of (i) avoiding tax-related penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any tax-related matters addressed herein. If you would like a written opinion upon which you can rely for the purpose of avoiding penalties, please contact us.

Introduction Robert S. Keebler, CPA, MST, AEP (Distinguished) Keebler & Associates, LLP 420 S. Washington St. Green Bay, WI 54301 Phone: (920) 593-1701 Robert.Keebler@keeblerandassociates.com

Outline For Today 2010 estate/gift/GST tax overview 2010 “modified carryover basis” rules Choosing between paying estate tax in 2010 vs. electing into the “modified carryover basis” rules IRS News Release Notice 2011-66 Rev. Proc. 2011-41

IRS News ReleaseDated August 5, 2011 Form 8939 is due November 15, 2011 Form 8939 cannot be extended Form 8939 will be issued early this Fall Election out of 2010 FET on Form 8939 - Confirmed

Notice 2011–66 Dated August 5, 2011 Time and manner in which the executor of an estate of a decedent who dies in 2010 can elect out of the estate tax How a donor may elect out of automatic allocation of GST exemption for direct skips Due dates for the returns for the taxable year ending December 31, 2010 to allocate or opt out of automatic allocation of GST exemption Finally, this notice addresses other issues associated with the determination of Basis under § 1022 Applies to both executors and donors Rev. Proc. 2011–41 provides a safe harbor with regard to the interpretation and application of § 1022

Rev. Proc. 2011–44 Optional safe harbor guidance Focused on “§ 1022 Election” Election filed on Form 8939 Applies to executors of the estate of decedent who died in 2010 Basis will be determined under § 1022, not §1014

2010 Estate/Gift/GST Tax Overview

Prior Estate/Gift Tax Law 2010 No estate tax No GST tax $1,000,000 lifetime gift tax exemption amount with a flat 35% gift tax rate on taxable gifts over the exemption amount 2011 & Beyond $1,000,000 estate tax exemption amount with a maximum estate tax rate of 55% $1,000,000 lifetime gift tax exemption amount with a maximum gift tax rate of 55% GST tax reinstated Special GST rules under EGTRRA no longer apply

Summary of Prior & New Estate/Gift Tax Law

New Estate/Gift Tax Law The new estate/gift tax law which passed in Congress allows an estate to elect out of the estate tax for the 2010 tax year. § 1022 - The election is made on Form 8939. Effective date of law is made retroactive to 1/1/2010 $5,000,000 estate tax exemption Indexed for inflation in 2012 35% marginal estate tax rate Election out of the estate tax would result in application of the modified carryover basis rules

New Estate/Gift Tax Law The general presumption under the new estate/gift law is that the estate tax applies to all estates in 2010 Thus, one will need to affirmatively elect out of the estate tax This will be termed “Section 1022” Election Reunification of the gift and estate tax exemptions $5,000,000 gift tax exemption (with a 35% gift tax rate) would apply to gifts after 12/31/2010 Thus, the gift tax exemption in 2010 would remain $1,000,000 (with a 35% gift tax rate)

New Generation-Skipping Transfer (GST) Tax Law 2010 GST Exemption Amount: $5,000,000 Available in 2010 regardless of whether the executor of an estate of a 2010 decedent makes the election to apply the EGTRRA 2010 estate tax rules and carry over basis rules GST Tax Rate: 0% As a result, transfers and distributions to skip persons in 2010 will not be trigger a GST tax 2011 & 2012 GST Exemption Amount: $5 Million GST Tax Rate: 35%

New Generation-Skipping Transfer (GST) Tax Law Section 101(a)(1) of the 2010 Act extends the EGTRRA modifications to the rules regarding various technical aspects of the GST tax Sunset of provisions extended to December 31, 2012 include: Automatic allocation rules for indirect skips Ability to perform qualified severance of trusts with mixed inclusion ratios Unnatural order of death provisions Allows retroactive allocation when death occurs after a transfer Extensions of GST exemption allocations Allows for extensions of GST allocations and elections into or out of automatic allocation rules Relief provided through PLR process

New Generation-Skipping Transfer (GST) Tax Law Substantial compliance rules Substantial compliance with the statutory and regulatory requirements for allocating GST exemption will suffice to establish that GST exemption was allocated to a particular transfer or a particular trust Value for determining inclusion ratio For timely and automatic allocations of GST tax exemption, the value of the property for purposes of determining the inclusion ratio is its finally determined gift tax value or estate tax value. In the case of a GST tax exemption allocation deemed to be made at the conclusion of an ETIP, the value for purposes of determining the inclusion ratio is its value at that time.

Remainder of Presentation GST issues – Notice 2011–66 2010 modified carryover basis rules – Rev. Proc. 2011–41 Fiduciary issues Conflicting tax filing Holding period and depreciation provisions Passive loss rules Reporting requirements choosing between 2010 estate tax versus modified carryover basis

2010 Modified Carryover Basis Rules

Section 1014 – Basis of Property Acquired from a Decedent(For Deaths Occurring Before or After 2010) In general, the basis of property in the hands of a person acquiring the property from a decedent or to whom the property passed from a decedent shall be the fair market value of the property as of the date of the decedent's death. However, if the “alternative valuation date” (generally six months after the decedent’s death) is used to value the property for estate tax purposes, then the basis of the property shall be the fair market value of the property as of the alternative valuation date. CAVEAT: The above basis rule does not apply to property considered to be “income in respect to a decedent” (“IRD”) as defined under § 691(a).

Section 1014 – Basis of Property Acquired from a Decedent(For Deaths Occurring Before or After 2010) Case 1 (Step-Up) Decedent has stock with $100 basis per share and $300 fair market value at date of death. The individual who inherits the property will be treated as if they purchased the stock at the $300 per share value when the shares are disposed of. Case 2 (Step-Down) Same facts as Case 1, except fair market value at the date of death is $35 per share. There will be a basis step-down of $65 per share when the property is transferred to the beneficiary.

Section 1014 – Basis of Property Acquired from a Decedent(For Deaths Occurring Before or After 2010) Case 3 (Joint Tenancy Property) Jim and Jane purchase a 50% interest in joint tenancy property for $100 a piece. A year later Jim passes away and at that time a 50% interest in that piece of property is worth $200. Jane will receive a step-up on Jim’s 50% portion that he inherits and have $300 (i.e. $100 + $200) of basis for the other interest in the property. Case 4 (Community Property) Same facts as Case 3, except Jim and Jane are husband and wife and the property is community status. Once either of the spouses passes away, the remaining spouse will receive a full step-up in basis to the fair market value of the property at the date of the first spouses passing (or the alternative valuation date). In the facts listed in Case 3 Jane would take a $400 basis in the entity at the date of Jim’s death.

Section 1223 - Holding Period of Property(For Deaths Occurring Before or After 2010) In the case of a person acquiring property from a decedent OR to whom property passed from a decedent, if: (a) the basis of such property in the hands of such person is determined under § 1014, and (b) such property is sold or otherwise disposed of by such person within one year after the decedent's death, then such person shall be considered to have held such property for more than one year(i.e. long-term capital gain).

Section 1223 - Holding Period of Property(For Deaths Occurring Before or After 2010) Case 5 (Short-Term Holding Period at Death) Phil purchased shares of XYZ, Inc. six months before his passing. Coral, Phil’s daughter, inherits the stock and sells it one month later at a gain. Coral’s holding period starts at the day of her father’s death and will recognize long-term capital gain upon the disposition of the property.

Section 1022(a) – Basis of Property Acquired from a Decedent(For Deaths Occurring During 2010) In general, the basis of property in the hands of a person acquiring the property from a decedent or to whom the property passed from a decedent shall be the lesser of: (1) the adjusted basis of the decedent or (2) the fair market value of the property as of the date of the decedent's death. CAVEAT: The above basis rule does not apply to property considered to be “income in respect to a decedent” (“IRD”) as defined under § 691(a).

Section 1022(a) – Basis of Property Acquired from a Decedent(For Deaths Occurring During 2010) Case 6

Property to Which Basis Adjustment Applies(For Deaths Occurring During 2010) Property owned by and acquired from the decedent: Property owned by decedent outright Property held by Qualified Revocable Trust Decedent’s interest in jointly held property Both halves of community property

Common examples of property receiving different treatment under the provisions of Code Sections 1014 and 1022 are: General Power of Appointment Marital Trust Qualified Terminable Interest Property (“QTIP”) Qualified Personal Residence Trust (QPRT) Grantor Retained Annuity Trust (GRAT)

Exclusion for Gain on Sale of Principal Residence IRC Section 121 excludes up to $250,000 of gain ($500,000 for married taxpayers filing jointly) on the sale of the home if the property was owned and used by the taxpayer as his principal residence for at least two years out of the five-year period ending on the date of sale. Under the basis step-up rules of IRC Section 1014, an estate could not satisfy the two-year requirement for application of IRC Section 121 and an heir would have to move into the house and live there for two years before the exclusion would apply. However, because the basis of the house was already stepped up to a fair market value under Section 1014. Under the modified carryover basis rules, basis can only be stepped up if some or all of the $1.3 million or $3.0million basis increase is used. Congress added Section 121(d)(11) to provide that an estate or an heir that sells a home satisfies the two-year requirement if the decedent would have satisfied the requirement at the time of her death.

Section 1022(b) – Aggregate Basis Step-Up (Non-Spousal Beneficiaries)(For Deaths Occurring During 2010) In the case of a non-spouse beneficiary, there is an “aggregate basis increase” of up to $1,300,000. The “aggregate basis increase” of $1,300,000 is also increased by the following items that decedent had at the time of death: Capital loss carryovers (§ 1212(b)) Net operating loss (NOL) carryovers (§ 172) Any losses that would have been allowed under § 165 if the property had been sold at fair market value immediately before the decedent’s death The executor may allocate the “aggregate basis increase” to any particular property The basis step-up for a particular asset cannot exceed its fair market value

Section 1022(b) – Aggregate Basis Step-Up (Non-Spousal Beneficiaries)(For Deaths Occurring During 2010) Case 7 Tom, a single man, dies with the following property: Total Step-Up $1,300,000

Section 1022(b) – Aggregate Basis Step-Up (Non-Spousal Beneficiaries)(For Deaths Occurring During 2010) Case 8 Steve, a single man, dies on January 1, 2010 with an estate consisting of $21,000,000 of XYZ, Inc. The stock’s basis was $1,000,000. Increase of $1,300,000 Likely to make § 1022 election

Section 1022(b) – Aggregate Basis Step-Up (Non-Spousal Beneficiaries)(For Deaths Occurring During 2010) Example 3. D owned 100 shares of stock that D held for profit within the meaning of Section 165(c)(2). The stock is a capital asset, and any gain or loss from the sale of the stock would be long-term capital gain or loss under Sections 1221 and 1222(3). D died in 2010, still owning the stock. As of D’s date of death, D’s adjusted basis in the stock pursuant to Section 1011 was $5,000, and the stock’s FMV on D’s date of death was $1,000. D did not sell the stock during life, and thus did not incur a loss under Section 165(c)(2) reportable on D’s final Form 1040. The stock is considered to be property owned by and acquired from D. D’s executor made the Section 1022 Election. If D had sold the stock immediately prior to D’s death, D would have had a net long-term capital loss of $4,000. Based on D’s 2010 taxable income, D would have been able to deduct $3,000 of the loss and $1,000 would have been carried over to future years. Section 1211(b). For purposes of Section 1022, however, the full unrealized net long-term capital loss of $4,000, that would have been available to D if D had sold the stock before death, is available as a Carryovers/Unrealized Losses Basis Increase.

Section 1022(b) – Aggregate Basis Step-Up (Non-Spousal Beneficiaries)(For Deaths Occurring During 2010) Case 9 Sam, a single man, dies on January 1, 2010 with an estate consisting of $11,000,000 of ABC, Inc. The stock’s basis was $1,000,000 except Sam had a capital loss carry-forward of $1,250,000. Same issues except that the basis increase will be $1,300,000 + $1,250,000 for a total of $2,550,000

Section 1022(b) – Aggregate Basis Step-Up (Non-Spousal Beneficiaries)(For Deaths Occurring During 2010) Case 10 Alan, a single man, died with unencumbered real estate with a fair market value of $5,000,000 and a depreciation basis of $0. Case 11 Same case except that the real estate is in a partnership with equal “inside” and “outside” basis.

Section 1022(b) – Aggregate Basis Step-Up Are QPRTs Eligible for the § 1022 Basis Increase? Example 1. On August 1, 2006, decedent (D) created a qualified personal residence trust (QPRT) pursuant to § 25.2702-5(c). The term of the QPRT expires on July 31, 2011. The QPRT instrument provided that, if D dies prior to July 31, 2011, the property in the QPRT is to be distributed to D’s child (C). D died in 2010, and D’s executor made the Section 1022 Election. In this case, the property in the trust had been transferred to the trust by D during D’s lifetime. The QPRT is not a qualified revocable trust as defined in Section 645(b)(1) nor is it a trust over which the decedent reserved the right to make any change in the enjoyment thereof through the exercise of a power to alter, amend, or terminate the trust. The property that passes to C under the QPRT instrument by reason of D’s death is not considered to have been acquired from D and thus, Section 1022 is not applicable to determine C’s basis in the property held in the QPRT. Instead, C’s basis in this property is determined under other applicable Sections of the Code. See Page 8 of Rev. Proc. 2011-41

Section 1022(b) – Aggregate Basis Step-Up Are QPRTs Eligible for the § 1022 Basis Increase? Example 2. Assume the same facts as in Example 1, except that the QPRT instrument provided that, if D dies prior to July 31, 2011, the QPRT terminates and the property in the QPRT is to be distributed to D’s estate. Because the trust property becomes the property of D’s estate at D’s death, the trust property is considered to have been acquired from D. Section 1022(e)(1). For the same reason, the property is also considered owned by D and, therefore, Basis Increase may be allocated to this trust property. See Page 8 of Rev. Proc. 2011-41

Section 1022(c) – Aggregate Basis Step-Up (Spousal Beneficiaries)(For Deaths Occurring During 2010) In the case of a spouse beneficiary, there is an “aggregate spousal property basis increase” of up to $3,000,000. The $3,000,000 basis step-up is in addition tothe $1,300,000 general basis step-up (including any basis step-up for any capital loss carryovers, NOL carryovers and/or current year § 165 losses the decedent had at the time of death) The executor may allocate the “aggregate basis increase” to qualified spousal property, defined as: Outright transfer property Qualified Terminable Interest Property (QTIP) Sales during estate administration must certify on Form 8939 that the net proceeds, will pass to the spouse Attach a copy of the will and/or trust to the Form 8939 See Page 12 of Rev. Proc. 2011-41

Spousal Basis Increase – For Estate Electing to Utilize the Carryover Basis Rules (cont’d) The surviving spouse has a qualifying income interest for life if: The surviving spouse is entitled to all the income from the property, payable annually or at more frequent intervals, or has a usufruct interest for life in the property under Louisiana law, and No person has a power to appoint any part of the property to any person other than the surviving spouse during the surviving spouses lifetime Code Section 1022 does not require that a QTIP election be made to qualify the property as a qualified income interest for life.

Section 1022(c) – Aggregate Basis Step-Up (Spousal Beneficiaries)(For Deaths Occurring During 2010) Case 12 Tim, a married man, dies with the following property: Total Step-Up $4,300,000

Section 1022(c) – Aggregate Basis Step-Up (Spousal Beneficiaries)(For Deaths Occurring During 2010) Limitation * Basis limited to fair market value

Section 1022(b) vs. 1022(c) Aggregate Basis Step-Up (For Deaths Occurring During 2010) Note: executor has authority to allocate the basis adjustment(s) among beneficiaries and specific assets (Sec. 1022(d)(3))

Section 1022(c) Sales During Estate Administration – Examples Example 4. D died in 2010 owning 20,000 shares of Corporation X stock. D’s executor made the Section 1022 Election. D’s adjusted basis in the stock is $600,000 ($30 per share), and the FMV on D’s date of death is $2,000,000 ($100 per share). Under the terms of D’s will, D’s Spouse (S) is to receive 50 percent of D’s estate, outright. Four months after D’s death, the FMV of the stock declines to $1,800,000 ($90 per share). D’s executor sells all 20,000 shares of the stock and receives $1,770,000 in proceeds net of sales commissions (thus, $88.50 per share). D’s executor intends to distribute all of the proceeds from the sale of the stock to S, in partial satisfaction of S’s residuary bequest; there are no known outstanding liabilities that would reduce this distribution. D’s executor may allocate up to $1,400,000 of Spousal Property Basis Increase ($70 to each of the 20,000 shares of stock) if the required certification and supporting documentation is included on a timely filed Form 8939. (Note that, to the extent that more than $58.50 per share is allocated to the stock, the sale will generate a loss.) See Pages 13 and 14 of Rev. Proc. 2011-41

Section 1022(c) – Aggregate Basis Step-Up (Spousal Beneficiaries)(For Deaths Occurring During 2010) Available for sale of property during estate administration1 [pages 12, 13 and 14 of Rev. Proc. 2011–41] Executor must certify that the net proceeds from the sale of § 1022(c) property will be distributed to or for the benefit of the decedent’s surviving spouse Executor must present a copy of the will or trust See Pages 12, 13 and 14 of Rev. Proc. 2011-41

Section 1022(c) Sales During Estate Administration – Examples Example 5. The facts are the same as in Example 4 except that D’s executor applies $165,000 of the net proceeds from the sale of the stock to pay administrative expenses of D’s estate. D’s executor intends to distribute the remaining $1,605,000 of net proceeds from the sale of the stock to S. Spousal Property Basis Increase may be allocated to no more than 18,135 shares. This number of shares is determined either by dividing the net proceeds to be distributed to S by the net per-share proceeds ($1,605,000 / $88.50 = 18,135.6 shares, limited for this purpose to 18,135 whole shares), or by calculating the ratio of the net proceeds payable to S to the total net proceeds (20,000 shares x $1,605,000 / $1,770,000 = 18,135.6 shares, thus limited to 18,135 whole shares). As in Example 4, D’s executor may allocate up to $70 of Spousal Property Basis Increase to each of these 18,135 shares of the stock (for a total of $1,269,450), all of the net proceeds of which will be distributed to S, provided a certification and supporting documentation are included on a timely filed Form 8939. See Pages 13 and 14 of Rev. Proc. 2011-41

Section 1022(c)Sales During Estate Administration – Examples Example 6. D died in 2010 owning personal property with an adjusted basis of $200,000 and a FMV on D’s date of death of $500,000. D’s executor made the Section 1022 Election. Under the terms of D’s will, D’s spouse (S) is to receive 50 percent of D’s estate, outright. Four months after D’s death, D’s executor sells the personal property for $600,000. D’s executor applies $150,000 of the net proceeds from the sale of the personal property to pay administrative expenses of D’s estate and intends to distribute the remaining $450,000 of net proceeds from the sale of the personal property to S. D’s executor may allocate no more than $225,000 of Spousal Property Basis Increase to the personal property. This maximum allocation is determined by multiplying the unrealized appreciation at death ($300,000) by the ratio of net proceeds to be distributed to S over the total net proceeds of the sale. Thus, D’s executor may allocate up to $225,000 ($300,000 X ($450,000 / $600,000)) of Spousal Property Basis Increase to the personal property, provided a certification and supporting documentation are included on a timely filed Form 8939. See Pages 13 and 14 of Rev. Proc. 2011-41

Section 1022(c) Sales During Estate Administration – ExamplesCharitable Remainder Trust Spousal Property Basis Increase also may be allocated to property held by a testamentary charitable remainder trust (CRT) as defined in Section 664 (subject to the limit of Section 1022(d)(2)) if the surviving spouse is the sole non-charitable beneficiary of the CRT and the CRT would have qualified for the marital deduction under Section 2056(b)(8) if the executor of the decedent’s estate had not made the Section 1022 Election. See Pages 14 of Rev. Proc. 2011-41

Section 1022(d) – Basis Step-Up Exceptions(For Deaths Occurring During 2010) The basis step-up provisions of §§ 1022(b) and 1022(c) do not applyto the following: Property which is considered “income in respect to a decedent” (“IRD”) Property which the decedent received by gift within three years of the decedent’s death Stock in any of the following entities: Foreign personal holding companies DISCs (or former DISCs) Foreign investment companies Passive foreign investment companies (unless such company is a “qualified electing fund”)

Section 1022(d) – Basis Step-Up Exceptions (Cont.)(For Deaths Occurring During 2010) The basis step-up provisions of §§ 1022(b) and 1022(c) do not apply to the following: Property over which the decedent held a power of appointment Property not owned by and acquired from decedent : QTIP trust, certain other trusts, and a portion of jointly held property

Allocation of BasisMethodology Pro Rata Method – each asset receives a pro rata share. Equal Basis – modifications are allocated to create an equal basis. Adjusted Equal Basis – modifications are allocated to create the same amount of taxation upon sale

Allocation of BasisMethodology

Section 1022 – Nonresident Aliens Who Are Not U.S. Citizens In the case of a decedent who was a nonresident alien and not a U.S. citizen, the basis increase is $60,000 rather than the general $1.3 million basis increase. Capital loss carryover, net operating loss carryover, and casualty loss adjustments do not apply. Example: Germaine dies with the following property: Germaine left her entire estate to her sister, Mary. Because of her status as a nonresident alien, Germaine’s estate can only allocate $60,000 of increased basis to the $550,000 difference between fair market value and basis. The total basis would not be $910,000. The executor of Jermaine’s estate will have to decide what asset(s) in which to allocate the $60,000 basis increase.

Income in Respect of a Decedent (IRD) Income in respect of a decedent (IRD)– is all items of gross income in respect of a decedent which were not properly included as taxable income in a tax period falling on or before a taxpayer’s death and are payable to his/her estate and/or another beneficiary

Income in Respect of a Decedent (IRD) Specific Items of IRD IRAs and other qualified retirement plans Unpaid salaries/wages at the time of death Dividends and interest earned, but not taxed, prior to death Unrecognized capital gain on an installment note at the time of the seller’s death Net Unrealized Appreciation (NUA) on employer securities (see later discussion)

To the extent that a decedent’s taxable estate includes items of IRD and a federal estate tax is assessed, the estate and/or its beneficiaries are entitled to an income tax deduction for the estate tax attributable to IRD This deduction is a miscellaneous itemized deduction NOT subject to the 2% AGI limitation IRC §691(c) Deduction

The income tax deduction computation for estate taxes paid on IRD is determined on a “with and without” basis In essence, the total deduction allowed is the difference between: (a) the estate tax liability with all items of IRD included in the taxable estate and (b) the estate tax liability without the IRD included in the taxable estate IRC §691(c) Deduction

IRC §691(c) Deduction Comprehensive Example On July 1, 2011, Jackie passed away leaving the following assets:

IRC §691(c) Deduction Comprehensive Example (cont.) Subsequent to Jackie’s death, the personal representative withdrew $50,000 from her IRA. Accordingly, the IRC §691(c) attributable to the $50,000 distribution would be as follows:

IRC §691(c) Deduction Comprehensive Example (cont.)

Notice 2011-66

Notice 2011-66
Method to Allocate Basis Timely filed Form 8939 Filed by executor If no executor appointed, filed by person in actual or constructive possession of property Recipient’s basis in property subject to adjustment upon IRS examination

Notice 2011-66 Reporting Requirements Form 8939 Allocation of Basis – Election out of the Estate Tax Due November 15, 2011 If one filed before November 15, 2011, a revised form can be filed if done on or before November 15, 2011 No extension available

Notice 2011-66 No protective Form 8939 that would only take effect if an estate tax audit results in increase of estate above applicable exclusion amount is allowed. It may be possible to challenge this position

Notice 2011-66 Relief from Form 8939 Filing Deadline Amended Form 8939 after deadline For sole purpose of allocating Spousal Property Basis Increase if: Original Form 8939 was timely filed and complete (except for the allocation for the Spousal Property Basis Increase) Amended Form 8939 filed no later than 90 days after the date of the distribution of the qualified spousal property to which Spousal Property Basis Increase is allocated on the amended Form 8939

Notice 2011-66 Relief from Form 8939 Filing Deadline If executor timely filed a Form 8939, an amended Form 8939 may be filed under Sec. 301.9100-2(b) (i.e. automatic six month extension) on or before May 15, 2012 Executor may request relief to supplement timely filed form under Sec. 301.9100-3 Limited to allocate basis increase that was not previously validly allocated Granted only if: After filing Form 8939, executor discovers additional property to which basis increase could be allocated; and/or The FMV of property reported on Form 8939 is adjusted as a result of IRS examination

GST Issues
Notice 2011-66

Notice 2011-66 GST Tax in 2010 GST tax was retroactively reinstated by TRUIRJCA and applies to the estates of all decedents who died after December 31, 2009, regardless of whether a Section 1022 Election is made. The GST tax is computed by multiplying the taxable amount by the applicable rate. For each GST occurring during 2010, the applicable rate is zero.

Notice 2011-66 GST Tax in 2010 (continued) As under the law applicable to GSTs occurring prior to 2010, the only way to achieve a “zero inclusion ratio” for the transfer is to make a timely allocation of GST exemption to the transfer. If the executor of a decedent who died in 2010 makes the Section 1022 Election, the executor allocates that decedent’s available GST exemption by attaching the Schedule R of Form 8939 to the Form 8939 for that decedent’s estate. If the Form 8939 is timely filed, this allocation will be considered a timely allocation of the decedent’s GST exemption under Section 2632.

Notice 2011-66 GST Tax in 2010 - Inter Vivos Direct Skips In the case of inter vivos direct skips that occurred in 2010, if the donor wishes to pay GST tax at the rate of zero percent and therefore does not wish to have any GST exemption allocated to that transfer, the donor may elect out of the automatic allocation of GST exemption to that direct skip in either of two ways: Donor affirmatively may elect out of the automatic allocation on a timely filed Form 709. A timely-filed Form 709 accompanied by payment of the GST tax (as shown on the return with respect to the direct skip) is sufficient to prevent an automatic allocation of GST exemption with respect to the transferred property.

Notice 2011-66 GST Tax in 2010 - Inter Vivos Direct Skips (continued) IRS will interpret the reporting of an inter vivos direct skip not in trust occurring in 2010 on a timely filed Form 709 as constituting the payment of tax (at the rate of zero percent) and as an election out of the automatic allocation of GST exemption to that direct skip. This interpretation also applies to a direct skip not in trust occurring at the close of an estate tax inclusion period (ETIP) in 2010 other than by reason of the donor’s death. This interpretation will not apply to any transfer in trust that is a direct skip or that occurs at the end of an ETIP. This interpretation will not apply to any direct skip, or to the close of an ETIP, by reason of the donor’s death.

Notice 2011-66 GST Tax in 2010 – Filing Deadlines Election to treat a trust as a GST trust or to allocate GST exemption to any inter vivos transfer other than a direct skip, is made on a timely filed Form 709. An individual may prevent the automatic allocation of GST exemption by so providing on a timely filed Form 709. TRUIRJCA extends the time for filing any return required to report a GST transfer made after December 31, 2009, and before December 17, 2010, to September 17, 2011.

Notice 2011-66 GST Tax in 2010 – Filing Deadlines (cont’d) Due date for filing a return reporting a direct skip, a taxable distribution, or a taxable termination (including any election required to be made on such return) that occurred on or after January 1, 2010, through December 16, 2010, is September 19, 2011, including extensions (because September 17, 2011, falls on a Saturday), except in the case of a Schedule R attached to Form 8939, which is due on or before November 15, 2011.

Notice 2011-66 GST Tax in 2010 – Filing Deadlines (cont’d) TRUIRJCA does not extend the due date of all gift and GST returns for 2010. Specifically, to the extent a return relates to an indirect skip, or to a post-December 16, 2010, direct skip, the due date of the return is not extended. Thus, the due date for filing a Form 709 that does not report a GST transfer or that reports a GST transfer (or any election pertaining to such transfer) that occurs on or after December 17, 2010, through December 31, 2010, was April 18, 2011, including extensions.

Notice 2011-66 GST Tax in 2010 – Filing Deadlines (cont’d) Due date for filing a Form 709 to elect to treat a trust as a GST trust or to allocate GST exemption to a transfer occurring during 2010 was April 18, 2011, including extensions. However, if a donor timely filed Form 709 for the taxable year ending December 31, 2010, but failed to allocate GST exemption to a transfer occurring during such year, see § 301.9100-2 for possible relief. An election out of automatic allocation is also possible.

Notice 2011-66 645 Election If executor elects carryover basis regime, a 645 election ends 2 years after the date of death

Notice 2011–66 Conflicting Tax Filings If both Form 8939 and Form 706 (or Form 706-NA) are filed IRS will require each person who filed Forms to signed restated Form 709 or Form 8939 within the 90-day period If not done, IRS will make determination on which election is made (estate tax vs. carryover basis) after considering all relevant facts and circumstances

Notice 2011–66Special Rules for Community Property1 Community property could receive a “step-down” in basis --“Lessor of Basis or FMV Rule” The surviving spouse’s one-half interest in that community property is eligible for allocation of the basis increase. See Pages 17,18,19 and 20 of Rev. Proc. 2011-41

Notice 2011–66Special Rules for Community Property1 Example 7. (i) D and D’s spouse (S) live in a community property state (State). D died in 2010, and D’s executor made the Section 1022 Election. At D’s death, Property X, community property, had an adjusted basis of $1,000,000 and a FMV of $8,000,000. D and S have a total of $100,000 of net operating losses under Section 172, after the deductions taken on D’s and S’s final joint Form 1040. $50,000 of the $100,000 of net operating losses would (but for D’s death) be carried from D’s last taxable year to a later taxable year of D. See Pages 17,18,19 and 20 of Rev. Proc. 2011-41

Notice 2011–66Special Rules for Community Property1 Under the community property laws of State, upon the death of a married person, one-half of the community property belongs to the decedent and the other one-half belongs to the surviving spouse. D bequeathed D’s one-half interest in Property X to D’s child (C). In this case, C acquired Property X by bequest, and therefore, Property X is acquired from D and is subject to the provisions of Section 1022. As a result, C’s basis in Property X under Section 1022(a)(2) is $500,000, the lesser of D’s adjusted basis in D’s one-half interest in Property X or the FMV of that interest at D’s death. In addition, because Property X is considered as owned by D at the time of death, General Basis Increase may be allocated to D’s interest in Property X. The executor of D’s estate has $1,300,000 in Aggregate Basis Increase and $50,000 (D’s share of the $100,000 of the unused net operating losses) in Carryovers/Unrealized Losses Increase available to allocate to the interest acquired by C in Property X. See Pages 17,18,19 and 20 of Rev. Proc. 2011-41

Notice 2011–66Special Rules for Community Property1 (ii) On the date of D’s death, the other one-half interest in Property X belongs to S under the laws of State. As a result, for purposes of Section 1022, S’s one-half interest in Property X is deemed to have been owned by and acquired from D. Under Section 1022(a)(2), S’s basis in S’s one-half interest in Property X is $500,000, the lesser of S’s adjusted basis in S’s one-half interest or the FMV of that interest as of D’s death. That interest has a FMV on D’s death of $4,000,000. See Pages 17,18,19 and 20 of Rev. Proc. 2011-41

Notice 2011–66Special Rules for Community Property1 (iii) The executor may allocate Basis Increase to S’s one-half interest in Property X. In this case, the executor decides to allocate $450,000 of Aggregate Basis Increase, $50,000 of Carryovers/Unrealized Losses Increase, and $3,000,000 in Spousal Property Basis Increase to S’s one-half interest in Property X. As a result, S’s basis in S’s one-half interest in Property X is $4,000,000 (the sum of S’s own adjusted basis of $500,000 and S’s allocated Basis Increase of the sum of $450,000, $50,000, and $3,000,000), equal to its FMV as of D’s date of death. D’s $50,000 in unused net operating losses is included in Basis Increase that is allocated by D’s executor to S’s interest in Property X; the other $50,000 of the unused net operating losses is available to S on S’s subsequent income tax returns. See Pages 17,18,19 and 20 of Rev. Proc. 2011-41

Notice 2011–66Special Rules for Community Property1 (iv) With respect to the one-half interest in Property X passing from D to C, the executor may allocate any or all of the remaining General Basis Increase of $850,000 to this property. In this case, the executor allocates the entire remaining $850,000 of General Basis Increase to C’s one-half interest in Property X. C’s basis in the one-half interest in Property X is $1,350,000 ($500,000 plus $850,000). See Pages 17,18,19 and 20 of Rev. Proc. 2011-41

Tax Character - Example Example 9. D owned tangible personal property (Section 1245 property) and claimed on D’s income tax return a depreciation deduction under Section 168 that would have been subject to recapture under Section 1245. D died in 2010 and D’s executor made the Section 1022 Election. D bequeathed all of D’s tangible personal property to D’s child (C). The property is Section 1245 property in the hands of C and therefore will be subject to recapture when sold by C, or whether the executor allocates any Basis Increase to that property. See § 1.1245-3(a)(3). See Section .06(2) [Page 21] of Rev. Proc. 2011-41

Holding Period, Character and Depreciation Holding Period – The recipient’s holding period matches the decedent’s Tax Character – The tax character does not change between the decedent and the heir Depreciation – The recipient will acquire the decedent’s basis and depreciation method

Depreciation Method(s) Original basis follows the same depreciation method in the hands of the decedent. Any increase in allocated basis is treated as a new asset that the recipient placed in service on the day after the decedent’s death.

IRC §469 – General Rules To the extent that a taxpayer does not “materially participate” in an activity (e.g. a limited partner interest in an investment partnership), losses generated by the activity (i.e. “passive activity”) cannot be used to offset other income (e.g. wages, interest, dividends, etc.) Such losses are referred to as “passive losses” “Passive losses” can only be used against “passive income” Any “passive losses” not used in the current year can be carried forward to future tax years to be used against future “passive income” Any unused “passive losses” can be used to offset other income in the year in which the “passive activity” is disposed of in a taxable transaction

IRC §469(g) – Treatment of Suspended Passive Losses at Death (For Deaths Not Occurring in 2010) To the extent that a deceased taxpayer has suspended passive losses at the time of death, a portion of the suspended loss will be deductible In order to be deductible, the suspended passive loss must exceed the difference between: The adjusted cost basis of the property in the hands of the transferee/heir (as determined under IRC §1014) OVER The adjusted cost basis of the property in the hands of the decedent NOTE: The purpose of this statute is to allow the decedent to utilize his/her passive loss to the extent it exceeds the cost basis step-up.

IRC §469(g) – Treatment of Suspended Passive Losses at Death (For Deaths Not Occurring in 2010) Example #1 FACTS FMV of passive activity @ death: $100,000 Decedent’s adjusted cost basis @ death: $10,000 Decedent’s suspended passive activity loss @ death: $50,000 RESULTS Adjusted cost basis – Transferee: $100,000 (i.e. FMV of activity @ death or $10,000 decedent’s adjusted cost basis + $90,000 cost basis step-up) Suspended passive loss recognized: $0 ($50,000 total suspended passive loss < $90,000 cost basis step-up) NOTE: None of the suspended passive loss is picked up because the cost basis step-up is greater than the suspended loss

IRC §469(g) – Treatment of Suspended Passive Losses at Death (For Deaths Not Occurring in 2010) Example #2 FACTS FMV of passive activity @ death: $100,000 Decedent’s adjusted cost basis @ death: $10,000 Decedent’s suspended passive activity loss @ death: $200,000 RESULTS Adjusted cost basis – Transferee: $100,000 (i.e. FMV of activity @ death or $10,000 decedent’s adjusted cost basis + $90,000 cost basis step-up) Suspended passive loss recognized: $110,000 ($200,000 total suspended passive loss - $90,000 cost basis step-up) NOTE: The suspended passive loss recognized is picked up on the decedent’s final individual income tax return

IRC §469(g) – Treatment of Suspended Passive Losses at Death (For Deaths Occurring in 2010) To the extent that a deceased taxpayer has suspended passive losses at the time of death, the gift tax rules with regard to transfers of passive activity interests (as determined under IRC §469(j)(6)) will apply Under IRC §469(j)(6), the adjusted basis of the passive activity passing from the donor to the donee will be increased by the amount of suspended passive losses However, such increase for suspended losses cannot exceed the passive activity’s FMV for purposes of determining a loss

IRC §469(g)– Treatment of Suspended Passive Losses at Death (For Deaths Occurring in 2010) Notwithstanding the general rule under IRC §469(j)(6), for a passive activity owned by and passing from a decedent (who dies in 2010), the excess of the decedent’s suspended passive loss over the adjusted basis of the passive activity (as determined under IRC §469(j)(6)) will be eligible as part of the “general basis increase” allowed for IRC §165 losses (under IRC §1022(b)(2)(C)(ii)) To the extent there is a gain on a hypothetical sale of the passive activity, the “special basis increase” (i.e. $1,300,000 under IRC §1022(b)(2)(B) or $3,000,000 under IRC §1022(c)(2)(B)) may be allocated to the adjusted cost basis of the property (but not in excess of the activity’s FMV)

IRC §469(g) – Treatment of Suspended Passive Losses at Death (For Deaths Occurring in 2010) Example #1 FACTS FMV of passive activity @ death: $100,000 Decedent’s adjusted cost basis @ death: $10,000 Decedent’s suspended passive activity loss @ death: $50,000 RESULTS Adjusted cost basis – Transferee: $60,000 ($10,000 decedent’s adjusted cost basis + $50,000 suspended passive activity loss) Suspended passive loss recognized: $0 ($50,000 total suspended passive loss - $50,000 basis step-up) NOTE: The transferee could increase his/her adjusted cost basis to $100,000 by the executor allocating an additional $40,000 of “special basis increase” to the passive activity. (However, no more than $40,000 of “special basis increase” could be allocated in that this would result in the adjusted cost basis being greater than the FMV @ death.)

IRC §469(g) – Treatment of Suspended Passive Losses at Death (For Deaths Occurring in 2010) Example #2 FACTS FMV of passive activity @ death: $100,000 Decedent’s adjusted cost basis @ death: $10,000 Decedent’s suspended passive activity loss @ death: $200,000 RESULTS Adjusted cost basis – Transferee: $100,000 (FMV of activity @ death) Suspended passive loss recognized: $0 (loss disallowed under IRC §469(j)(6)) NOTE: The $110,000 of loss ($200,000 suspended passive loss - $90,000 basis step-up) not allowed as an income tax deduction on the decedent’s final individual income tax return can be used to increase the adjusted cost basis of other property included in the decedent’s taxable estate.

Reporting Requirements Under Section 6018 Executor’s filing requirement Carryover basis property in excess of $1.3 million Property acquired by decedent within three years of death not treated as carryover basis property and not reported on a 709 Required information (i.e., recipient, property description, adjusted basis in hands of decedent, whether any gain on sale would be treated as ordinary income, decedent’s holding period, allocation of basis increase) $10,000 penalty for failure to file on time Executor also required to furnish information to persons named in the return

Reporting Requirements Under Section 6018

Choosing Between 2010 Estate Tax vs. Modified Carryover Basis

Summary of Prior & New Estate/Gift Tax Law

Comparison of Estate Tax Options in 2010 CAVEAT: The above table discusses the estate tax decision in a general context. Depending on the specific attributes of the estate, more analysis may need to be done to determine whether or not the estate tax should be elected.

Electing Into or Out of the Estate Tax Perhaps the single most important issue in determining whether or not to elect into the estate tax will be the total tax incurred under each scenario Need to compare estate tax rate vs. future ordinary income/capital gains tax rates If estate tax elected out of, then the future ordinary income/capital gains tax to be incurred will need to be reduced to its present value In most cases, the decision to elect into the estate tax can be made according to the following simple algebraic formula Current estate tax liability = Present value of future income tax liability

Electing Into or Out of the Estate Tax In more complex estates (i.e. ones with multiple tax bases, tax characteristics, and/or IRD), a thorough quantitative analysis will need to be performed In this situation, the decision to elect into the estate tax will usually be reached according to the following algebraic formula: Factors X = Gross estate Xb= Cost basis of gross estate Y = Estate tax exemption Z = Modified carryover basis increase Ry = Estate tax rate Rz = Income tax/capital gains tax rate Formula (X – Y) x Ry = ([X – Xb] – Z) x Rz

Electing Into or Out of the Estate TaxSimple Example #1* John dies in 2010 with a $5,000,000 gross estate. John’s gross estate consists of a variety of assets with an aggregate cost basis of $2,800,000. Given these facts, John’s estate would elect into the estate tax because the estate will likely not have an estate tax and likely will get a full cost basis step-up to the date-of-death value. OPTION 1 (Elect Into Estate Tax): Total tax liability = $0 OPTION 2 (Elect Out Of Estate Tax): Total tax liability = $330,000 * Assumes all assets are capital assets (with no depreciation recapture) and contain no IRD. Further it is assumed that the future capital gain tax rate is 15%.

Electing Into or Out of the Estate TaxSimple Example #2* Jane dies in 2010 with a $35,000,000 gross estate. Jane’s gross estate consists of a variety of assets with an aggregate cost basis of $25,000,000. Given these facts, Jane’s estate would elect out of the estate tax because the estate will likely have an estate tax that is greater than any income tax liability it would incur upon the future sale of the assets. OPTION 1 (Elect Into Estate Tax): Total tax liability = $10,500,000 OPTION 2 (Elect Out Of Estate Tax): Total tax liability = $1,500,000 * Assumes all assets are capital assets (with no depreciation recapture) and contain no IRD. Further it is assumed that the future capital gain tax rate is 15%.

Special Considerations Tax character of any future gains or earnings on assets Identity of the beneficiaries Cash needs of the beneficiaries Future income and estate tax rates Domicile of beneficiaries and personal income tax information Availability of asset-specific tax deductions and credits

Special Considerations Potential for disagreement among beneficiaries concerning the allocation of basis Conflicts of interest in making the election and allocating basis The availability of binding consents or court approval Whether a compensating equitable adjustment is appropriate, and whether it should be approved by a court

Special Considerations Impact of election on formula clauses Projected date of sale of each asset Ability to allocate basis Basis of each estate asset Date of death value of each estate asset Projected future value of each asset Projected earnings from each asset Calculation and apportionment of estate tax burden

Other Considerations Future depreciation “tax shield” Need to present value future benefit of income tax deductions Depreciation recapture IRC §1245 recapture – ordinary income tax rates IRC §1250 recapture – 25% tax rate IRC §754 election impact Impact of potential IRC §743(b) step-down State/local income taxes

Electing Into or Out of the Estate TaxComprehensive Example Martha dies in 2010 with a $20,000,000 gross estate. Martha’s gross estate consists of the following assets:

Electing Into or Out of the Estate TaxComprehensive Example (cont.)* * Assumes that income tax rates and capital gains rates remain at their 2010 levels for the indefinite future. Also, the future income tax liabilities do not take into consideration present value. Additionally, it is assumed that the $1,300,000 general basis step-up is allocated first to assets subject to recapture. Finally, the income tax rate on recapture is a blended rate between ordinary, 25% § 1250 gain and long-term capital gains.

Impact on Formula Clauses Spousal bequests Charitable bequests Bequests subject to GST tax

Impact on Formula ClausesSpousal BequestExample Alex's estate is valued at $15 million Alex's will provides, "the largest dollar amount which will not result in an estate tax to the Family Trust with the remainder to the Marital Trust” The executor elects not to pay the estate tax and to instead utilize the carryover basis rules The Family Trust will receive the entire $15 million with the Marital Trust receiving nothing. In the alternative, if the executor fails to make such an election, the Family Trust would receive $5 million with the remainder going to the Marital Trust

Critical Fiduciary Issues Executors need to seek written agreements between the beneficiaries Obtain judicial guidance on how to proceed

Impact on Disclaimers SPECIAL RULE 2010: Making any disclaimer described in § 2518(b) of such Code of an interest in property passing by reason of the death of such decedent, shall not be earlier than the date which is 9 months after the date of the enactment of this Act. Valid Under Federal Law Valid Under State Law Use of disclaimers to overcome formula clauses GST tax planning Additional funding of the “bypass trust”

Revenue Procedure 2011-41 Examples Example 1. On August 1, 2006, decedent (D) created a qualified personal residence trust (QPRT) pursuant to § 25.2702-5(c). The term of the QPRT expires on July 31, 2011. The QPRT instrument provided that, if D dies prior to July 31, 2011, the property in the QPRT is to be distributed to D’s child (C). D died in 2010, and D’s executor made the Section 1022 Election. In this case, the property in the trust had been transferred to the trust by D during D’s lifetime. The QPRT is not a qualified revocable trust as defined in section 645(b)(1) nor is it a trust over which the decedent reserved the right to make any change in the enjoyment thereof through the exercise of a power to alter, amend, or terminate the trust. The property that passes to C under the QPRT instrument by reason of D’s death is not considered to have been acquired from D and thus, section 1022 is not applicable to determine C’s basis in the property held in the QPRT. Instead, C’s basis in this property is determined under other applicable sections of the Code.

Revenue Procedure 2011-41 Examples Example 2. Assume the same facts as in Example 1, except that the QPRT instrument provided that, if D dies prior to July 31, 2011, the QPRT terminates and the property in the QPRT is to be distributed to D’s estate. Because the trust property becomes the property of D’s estate at D’s death, the trust property is considered to have been acquired from D. Section 1022(e)(1). For the same reason, the property is also considered owned by D and, therefore, Basis Increase may be allocated to this trust property.

Revenue Procedure 2011-41 Examples Example 3. D owned 100 shares of stock that D held for profit within the meaning of section 165(c)(2). The stock is a capital asset, and any gain or loss from the sale of the stock would be long-term capital gain or loss under sections 1221 and 1222(3). D died in 2010, still owning the stock. As of D’s date of death, D’s adjusted basis in the stock pursuant to section 1011 was $5,000, and the stock’s FMV on D’s date of death was $1,000. D did not sell the stock during life, and thus did not incur a loss under section 165(c)(2) reportable on D’s final Form 1040. The stock is considered to be property owned by and acquired from D. D’s executor made the Section 1022 Election. If D had sold the stock immediately prior to D’s death, D would have had a net long-term capital loss of $4,000. Based on D’s 2010 taxable income, D would have been able to deduct $3,000 of the loss and $1,000 would have been carried over to future years. Section 1211(b). For purposes of section 1022, however, the full unrealized net long-term capital loss of $4,000, that would have been available to D if D had sold the stock before death, is available as a Carryovers/Unrealized Losses Basis Increase.

Revenue Procedure 2011-41 Examples Example 4. D died in 2010 owning 20,000 shares of Corporation X stock. D’s executor made the Section 1022 Election. D’s adjusted basis in the stock is $600,000 ($30 per share), and the FMV on D’s date of death is $2,000,000 ($100 per share). Under the terms of D’s will, D’s Spouse (S) is to receive 50 percent of D’s estate, outright. Four months after D’s death, the FMV of the stock declines to $1,800,000 ($90 per share). D’s executor sells all 20,000 shares of the stock and receives $1,770,000 in proceeds net of sales commissions (thus, $88.50 per share). D’s executor intends to distribute all of the proceeds from the sale of the stock to S, in partial satisfaction of S’s residuary bequest; there are no known outstanding liabilities that would reduce this distribution. D’s executor may allocate up to $1,400,000 of Spousal Property Basis Increase ($70 to each of the 20,000 shares of stock) if the required certification and supporting documentation is included on a timely filed Form 8939. (Note that, to the extent that more than $58.50 per share is allocated to the stock, the sale will generate a loss.)

Revenue Procedure 2011-41 Examples Example 5. The facts are the same as in Example 4 except that D’s executor applies $165,000 of the net proceeds from the sale of the stock to pay administrative expenses of D’s estate. D’s executor intends to distribute the remaining $1,605,000 of net proceeds from the sale of the stock to S. Spousal Property Basis Increase may be allocated to no more than 18,135 shares. This number of shares is determined either by dividing the net proceeds to be distributed to S by the net per-share proceeds ($1,605,000 / $88.50 = 18,135.6 shares, limited for this purpose to 18,135 whole shares), or by calculating the ratio of the net proceeds payable to S to the total net proceeds (20,000 shares x $1,605,000 / $1,770,000 = 18,135.6 shares, thus limited to 18,135 whole shares). As in Example 4, D’s executor may allocate up to $70 of Spousal Property Basis Increase to each of these 18,135 shares of the stock (for a total of $1,269,450), all of the net proceeds of which will be distributed to S, provided a certification and supporting documentation are included on a timely filed Form 8939.

Revenue Procedure 2011-41 Examples Example 6. D died in 2010 owning personal property with an adjusted basis of $200,000 and a FMV on D’s date of death of $500,000. D’s executor made the Section 1022 Election. Under the terms of D’s will, D’s spouse (S) is to receive 50 percent of D’s estate, outright. Four months after D’s death, D’s executor sells the personal property for $600,000. D’s executor applies $150,000 of the net proceeds from the sale of the personal property to pay administrative expenses of D’s estate and intends to distribute the remaining $450,000 of net proceeds from the sale of the personal property to S. D’s executor may allocate no more than $225,000 of Spousal Property Basis Increase to the personal property. This maximum allocation is determined by multiplying the unrealized appreciation at death ($300,000) by the ratio of net proceeds to be distributed to S over the total net proceeds of the sale. Thus, D’s executor may allocate up to $225,000 ($300,000 X ($450,000 / $600,000)) of Spousal Property Basis Increase to the personal property, provided a certification and supporting documentation are included on a timely filed Form 8939.

Revenue Procedure 2011-41 Examples Example 7. D owned tangible personal property (section 1245 property) and claimed on D’s income tax return a depreciation deduction under section 168 that would have been subject to recapture under section 1245 if D had sold the property prior to D’s death. D died in 2010 and D’s executor made the Section 1022 Election. D bequeathed all of D’s tangible personal property to D’s child (C). Because C’s basis is determined under section 1022, the property is section 1245 property in the hands of C and therefore will be subject to recapture under section 1245 when sold by C, regardless of whether the property is depreciable property in the hands of C or whether the executor allocates any Basis Increase to that property.

Revenue Procedure 2011-41 Examples Example 8. D owned an apartment building that generated losses that have been disallowed under section 469. D died in 2010 and D’s executor made the Section 1022 Election. The building is property owned by and acquired from D. Pursuant to D’s will, D’s child (C) is to acquire the building. On D’s date of death, the FMV of the building was $100,000, the basis of the building was $10,000, and the suspended passive activity losses allocable to the building were $50,000. Pursuant to section 469(j)(6), the $50,000 in suspended passive activity losses are added to D’s basis of $10,000, resulting in an adjusted basis of $60,000. For purposes of section 1022(b)(2)(C)(ii), a hypothetical sale of the property just before D’s death would have produced a gain of $40,000 ($100,000 FMV less D’s adjusted basis of $60,000), so there is no loss under section 165 from this property. C’s basis in the building as of D’s date of death is $60,000, plus any amount of the General Basis Increase allocated to this property.

Revenue Procedure 2011-41 Examples Example 9. Assume the same facts as in Example 8, except that the suspended passive activity losses allocable to the building are $200,000 instead of $50,000. Pursuant to section 469(j)(6), the $200,000 in suspended passive activity losses are added to D’s basis of $10,000 resulting in an adjusted basis of $210,000. Under section 1022(a)(2), C’s basis in the building is $100,000 (the lesser of D’s adjusted basis in the building ($210,000) and the building’s FMV on the date of death ($100,000)). Thus, C’s basis in the building reflects $90,000 of the section 469 suspended losses. If the property had been sold at FMV immediately before D’s death, a section 165 loss of $110,000 would have been allowable (FMV of $100,000 minus $210,000 of D’s adjusted basis). This $110,000 constitutes the section 165 loss that may be included in the General Basis Increase.

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Analyzing the Carryover Basis Election Impact 2010 Estates