Mid-Atlantic Health Law TOPICS

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Future Heirs Beware

As discussed in detail in the Fall edition of TOPICS, the Economic Growth and Tax Relief Reconciliation Act of 2001 (the 2001 Act) significantly reduces the amount of federal estate taxes payable upon the death of wealthy individuals, including high income earning health care professionals. What many may not realize, however, is that a lesser-known provision of the 2001 Act significantly increases the amount of income taxes payable by an heir who inherits property from a decedent who dies after 2009, if that heir subsequently sells the inherited property. When an asset is sold at a gain, a federal capital gains tax is imposed. "Gain" is generally computed as the difference between the asset's sales price and its original cost (less depreciation, if applicable). The cost of an asset, less any depreciation, is generally referred to as the "basis" in the asset. Under the rules in effect prior to the enactment of the 2001 Act, an heir who inherited assets from a decedent would get a "step-up" in the basis of those assets that was equal to the fair market value of the assets on the decedent's date of death. This rule could be of tremendous benefit to an heir who inherited assets which he or she thereafter decided to sell. For example, an heir who inherited stock from a decedent, who purchased the stock for $2,000, would have a basis that was equal to the fair market value of the stock on the decedent's date of death, rather than the $2,000 purchase price of the stock. If the decedent died when the stock was valued at $120,000, and the heir thereafter sold the stock for $150,000, the gain would be limited to $30,000 because of the step-up in basis rules. If the tax savings generated by the step-up in basis rules sounds too good to be true, it now is - courtesy of the 2001 Act. Under the new basis rules implemented by the 2001 Act, an heir who inherits property from a decedent who dies after 2009 will have a basis in the property equal to the lesser of the decedent's adjusted basis or the fair market value of the property on the decedent's date of death. Thus, the unsuspecting heir, who inherits and then sells the stock in the above example, could be stuck with the decedent's adjusted basis in those shares, which would result in a $148,000 gain. Even worse, if the decedent's basis in the shares could not be determined because of poor record keeping, the basis will be deemed to be zero, resulting in an even greater gain. Accordingly, instead of paying about $6,000 in federal capital gains taxes under the old rules, the heir will pay about $30,000 under the new rules. So what does this mean for you? As an owner of property, you should keep detailed records of your basis in that property and advise others -while you are alive and have the ability to do so- of the location of your records. As a potential heir, you should familiarize yourself with the new basis rules so that you can make an informed decision about retaining or disposing of inherited property. Although there are limited exceptions to the new basis rules that allow the Personal Representative of a decedent's estate to allocate additional basis to certain property, prudent individuals will act now to ensure that their heirs receive the maximum benefit from their inheritances, by good recordkeeping and by considering the adoption of systematic gift giving programs or other estate planning tools.


December 21, 2001




Johnson, Laura L.


Health Care