If you’re in line to inherit property from a parent or other loved one, it’s critical to understand the basis consistency rules. Tax law provides that the income tax basis of property received from a deceased person cannot exceed the property’s fair market value (FMV) as finally determined for estate tax purposes.

Current law

The current tax law regarding the basis consistency rules, passed in 2015, prohibits beneficiaries from arguing, as they did with some success in the past, that the estate undervalued the property and, therefore, they’re entitled to claim a higher basis for income tax purposes. The higher the basis, the lower the gain on any subsequent sale of the property.

The law also requires estates to furnish information about the value of such property to the IRS and the person who inherits it.

Prior law

Under prior law, estates and their beneficiaries had conflicting incentives when it came to the valuation of a deceased person’s property. Executors had an incentive to value property as low as possible to minimize estate taxes, while beneficiaries had an incentive to value property as high as possible to minimize capital gains, should they sell the property.

Generally, under Internal Revenue Code Section 1014, the basis of property received from the deceased is equal to its FMV on the date of his or her death. The property’s value for estate tax purposes is deemed to be its FMV for inheritance purposes. However, in the past, beneficiaries could sometimes rebut this presumption with clear and convincing evidence that the estate had undervalued the property (provided they weren’t involved in the estate valuation).

To prevent beneficiaries from challenging a property’s estate tax value, the 2015 law added Secs. 1014(f) and 6035. Sec. 1014(f) requires consistency between a property’s basis reflected on an estate tax return and the basis used to calculate gain when it’s sold by the person who inherits it. It provides that the basis of property in the hands of a beneficiary may not exceed its value as finally determined for estate tax purposes or, if no such determination has been made, the value reported according to Sec. 6035. That section requires estates to furnish certain information about inherited property, including “a statement identifying the value of each interest in such property as reported on such return,” to the IRS and to each person acquiring an interest in the property.

An asset’s value is finally determined when 1) its value is reported on a federal estate tax return and the IRS doesn’t challenge it before the limitations period expires, 2) the IRS determines its value and the executor doesn’t challenge it before the limitations period expires, or 3) its value is determined according to a court order or agreement.

Estates that fail to comply with the new reporting requirements are subject to failure-to-file penalties. Beneficiaries who claim an excessive basis on their income tax returns are subject to accuracy-related penalties on any resulting understatements of tax. 

Not so fast . . .

Sec. 1014(f) contains a significant exception to the basis consistency rules: These rules don’t apply to property unless its inclusion in the deceased’s estate increased the liability for estate taxes. So, for example, the rules don’t apply if the value of the deceased’s estate is less than his or her unused exemption amount. Proposed regulations clarify that, if the estate is liable for estate tax, all property included in the gross estate is subject to the basis consistency rules, unless it qualifies for the marital or charitable deduction or isn’t required to be appraised.

An accurate valuation is key

The basis consistency rules can be complex. The bottom line is that, if you’re going to be inheriting property from a person whose estate is liable for estate tax, it’s important that the property’s value be accurately reported on the deceased’s estate tax return.