Practitioners involved with the administration of trusts and estates of a decedent may be confronted with the issue of dealing with one or more assets of a decedent discovered after the administration is believed to have been concluded. Consideration of timely reporting of those assets for estate tax purposes may be essential to avoiding assignment of a zero basis to such assets.[1]
The recipient of property from a decedent generally takes a basis equal to the fair market value of the property at the time of the decedent’s death (or the alternate valuation date (i.e., six-months after the decedent’s date of death)) pursuant to Section 1014(a) of the Internal Revenue Code of 1986, as amended (the “IRC”). However, under Proposed Regulations issued in 2016 addressing the so-called consistent basis reporting rules, the basis of inherited property may unexpectedly be determined to be zero.
The relevant Proposed Regulations under IRC Section 1014(f), which remain as proposed to this date, result from enactment of the Surface Transportation and Veterans Health Care Choice Improvement Act of 2015 containing provisions requiring consistency between the basis of inherited property in the hands of the recipient and the value of that property reported for federal estate tax purposes. The Proposed Regulations are intended to address the situation where a decedent’s estate reports a discounted value for property generating a lower value for estate tax purposes and the recipient reports a higher basis for the property pursuant to IRC Section 1014(a) resulting in a lower income tax liability upon the subsequent disposition of the property. IRC Section 1014(f) provides that the inherited property may not exceed the value of the property as finally determined for Federal estate tax purposes.
The final value of property for federal estate tax purposes (i.e., the inherited basis of the property received by the recipient pursuant to IRC 1014(a)) pursuant to IRC Section 1014(f)(3) and Prop. Regs. Sec. 1.1014-10(c) is (i) the value reported on a filed federal estate tax return, which is not contested by the Internal Revenue Service (“IRS”) before the limitation period on assessment expires, (ii) the value determined by the IRS, which is not timely contested by the estate, or (iii) the value determined by a court or pursuant to a settlement agreement binding on all parties. The general period of time for assessing an estate tax is three years from the due date of an estate tax return pursuant to IRC Section 6501(a), but an extended six-year period may apply pursuant to IRC Section 6501(e)(2) if there is an omission of 25 percent or more of the gross estate. There is no statute of limitation on the period for assessment in the case where no estate tax return is filed.
The zero-basis issue arises when property is discovered after filing of the estate tax return or is otherwise omitted from the estate tax return, as well as in the case where a required estate tax return is not filed. It is important to note that the consistent basis rules only apply to property whose inclusion in the gross estate would result in estate tax liability or would result in an increase in estate tax liability. If the after-discovered or omitted property would have resulted in estate tax liability or an increase in estate tax liability had such asset been reported, paragraph (A) or (B) of Prop. Regs. Sec. 1.1014-10(c)(3)(i) prescribes the final value of the property as follows: (A) if the after-discovered or omitted property is reported on a supplemental estate tax return filed before expiration of the assessment period, the final value is determined as described above under Prop. Regs. Sec. 1.1014-10(c), or (B) if the after-discovered or omitted property is not reported before expiration of the assessment period, the final value of the property is zero. Note that a supplemental return may only be filed within the assessment period. As such, in some cases, it may be too late to file a supplemental estate tax return and rectify the zero basis. In the case where a required federal estate tax return is not filed, Prop. Regs. Sec. 1.1014-10(c)(3)(ii) provides that the final value of all property includible in the gross estate subject to the consistent basis requirement is zero until the final value is determined as described above under Prop. Regs. Sec. 1.1014-10(c), generally requiring the filing of an estate tax return.
The consistent basis reporting rules make clear the importance of identifying and marshaling all assets of a decedent. An example in Prop. Regs. Sec. 1.1014-10(e) illustrates the risk of not identifying and not including all assets, as follows: After the expiration of the period for assessing the estate tax, the executor discovers property that had not been reported on the required return which, if reported, would have increased the estate tax due. The final value of the unreported property is zero, and a sale of the inherited property by the recipient may be liable for tax on the full amount realized on sale of the property.
Equally important when an estate is nearing the level at which an estate tax return is required is the executor’s obtaining an appraisal of any property of the decedent without a readily ascertainable market value. For example, if an appraisal of an investment property of the decedent is not obtained and the executor determines that no estate tax return is required, the recipient of the property may upon a future sale of the property face a request from the IRS to substantiate the basis of the property. Obtaining an appraisal of an investment property some years after the estate is concluded can be challenging. If the IRS determines the value of the investment property was sufficient to require an estate tax return and would have resulted in estate tax liability, the property not only may be assigned a zero basis unless and until an estate tax return is filed, but also penalties may be applicable and assessed for failure to timely file and pay the estate tax.
In summary, it is incumbent on executors of estates and those representing the executors to carefully determine the assets of a decedent and their accurate values, as well as the parameters for filing an estate tax return and the risks associated with not filing a return when the values of assets approach the relevant level requiring an estate tax return.
[1] In addition to assets receiving a zero basis, if an executor omits one or more assets of the decedent on the estate tax return, interest and penalties may be assessed for failing to report, and the receipt of a closing letter from the IRS may not shield the estate from such interest and penalties.
[View source.]
