What Is IRC 1022 Modified Carryover Basis?
For estates in 2010, IRC 1022 offered a unique alternative to the estate tax, allowing an executor to modify the tax basis of inherited property.
A unique tax situation arose from legislation affecting the 2010 tax year. The Tax Relief Act of 2010 retroactively reinstated the federal estate tax, but it also gave executors for individuals who died in 2010 a choice to opt out. For estates that opted out, an alternative method under Internal Revenue Code (IRC) Section 1022, the modified carryover basis system, applied. This election changed how the tax basis of inherited assets was determined for beneficiaries, affecting the calculation of potential capital gains when those assets were sold.
The Modified Carryover Basis System
Tax basis is the amount of your investment in a property for tax purposes. Under the standard rules of IRC Section 1014, an heir receives a “stepped-up basis” for inherited property. This means the heir’s basis becomes the asset’s fair market value (FMV) on the date of the owner’s death, which reduces or eliminates capital gains tax if the property is sold immediately.
The alternative is a “carryover basis,” where the heir assumes the decedent’s original basis in the property. If a stock was bought for $10 and was worth $100 at death, the heir’s basis would be $10, and a sale at $100 would create a $90 taxable gain.
For estates using the 2010 election, the heir’s basis in an inherited asset was the lesser of the decedent’s adjusted basis or the property’s FMV at death. If an asset had depreciated in value, the heir received a “stepped-down” basis. The “modified” aspect allowed the executor to strategically increase the basis of certain assets.
Applying the Permitted Basis Increases
The executor could allocate specific amounts to increase the basis of inherited assets. The code provided for two distinct pools of basis increases that could be applied to appreciated property. These increases, however, could not raise an asset’s basis above its fair market value on the date of the decedent’s death. The decision of how to distribute these increases was left to the executor’s discretion.
The first was a $1.3 million General Basis Increase. An executor could allocate this amount across any qualifying property owned by the decedent and acquired by a beneficiary. This allocation was flexible, allowing the executor to apply it to a single asset or spread it among many different assets to minimize future capital gains.
A separate $3 million Spousal Property Basis Increase was also available. This increase could only be allocated to property transferred outright to a surviving spouse or to certain qualifying trusts. This meant that for property passing to a spouse, a total of up to $4.3 million in basis increases could be applied.
The strategic allocation of these increases was a responsibility for the executor. They had to consider which assets were most likely to be sold and the tax situations of the beneficiaries. It was often more advantageous to allocate basis to assets that would produce ordinary income upon sale.
Information and Documentation for the Election
The formal election and allocation were reported to the IRS on Form 8939, “Allocation of Increase in Basis for Property Acquired From a Decedent.” To complete this form, the executor had to gather comprehensive information to make informed decisions about the basis allocations.
The first step was to create a complete inventory of all property the decedent owned at death, excluding cash. For each asset, the executor was required to determine the decedent’s adjusted basis and the asset’s fair market value on the date of death. Determining the decedent’s original basis could be challenging.
This data was used to populate Form 8939. The form required a description of each asset, the recipient’s name and taxpayer identification number, the decedent’s basis, and the date-of-death FMV. Schedules on the form documented the allocation of the basis increases, which created the official tax basis for the heirs.
The Filing and Election Procedure
With the necessary information gathered and allocation decisions made, the executor filed the signed Form 8939 with the IRS. The final due date for filing this form was January 17, 2012.
The election to use the modified carryover basis system was irrevocable. However, the IRS did allow for limited amendments to a timely filed form, such as to properly allocate the Spousal Property Basis Increase after assets were distributed.
Upon filing, the basis of the inherited properties was officially established for all future tax purposes. Beneficiaries received a statement from the executor detailing the basis of the property they inherited. The modified carryover basis system was a one-time provision for estates of decedents who died in 2010 and is not an option for current estates.