DEAR BENNY: Your recent article about the man who wanted to gift his house to a friend raised a question in my mind. Suppose the house received a stepped-up basis after the man’s wife died. If he then gifts the house to the friend, does the friend receive the stepped-up basis as his tax basis and does the man have to deduct the stepped-up basis from his lifetime exclusion? –Bob
DEAR BOB: First, this year there really is no step up in basis. Let me first explain what that was.
Example: A husband and wife bought property many years ago for $50,000. The husband dies and the value of the property at the time of death was $400,000. Assume there were no improvements. The basis for tax purposes for each spouse was $25,000 each. But on the husband’s death, half of the fair-market value — namely $200,000 — is added (i.e., stepped up) to the wife’s tax basis, and now her basis is $225,000.
However, for 2010, Congress repealed this concept and substituted what tax attorneys are calling a “modified carry-over basis.” Oversimplified, in our example, the new basis for the wife would be the lesser of the husband’s adjusted basis or the fair-market value of the property at the time of death. In other words: only $25,000 would be added to the wife’s basis, which would then become only $50,000.
It should be noted that even this has a limitation. Under no circumstances can the basis be more than $1.3 million. But if the property was passed to the surviving spouse, it can be increased by an additional $3 million. There is movement in Congress to amend the law, but don’t hold your breath in a controversial election year. Hopefully, the stepped-up basis will return in 2011.
But to answer your specific question: Assuming a stepped-up basis exists, the husband would get that benefit. If he then gifts the property to a friend, that friend takes advantage of the new tax basis. General rule: The basis of the giver of the gift – the donor – becomes the basis of the receiver.
And the donor would have to report to the Internal Revenue Service the amount of the gift, less $13,000, which is free from gift tax. This would be deducted from his lifetime gift allowance.
Note: The laws may differ in community property states, and readers should consult with their legal and financial advisers about their specific situation.
Benny Kass is a practicing attorney in Washington, D.C., and Maryland. No legal relationship is created by this column. Questions for this column can be submitted to firstname.lastname@example.org.