Capital Gains on Inherited Property
When a taxpayer inherits property from a deceased individual, capital gains often come into play if they decide to liquidate the asset. The IRS has specific rules that govern how capital gains on inherited property are treated in regard to taxes.
Holding Period
Property acquired from a decedent is treated as having been held for more than a year if:
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The person selling the property has a basis that is determined under the rules for inherited property, and
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The property is disposed of within one year after the date of the decedent’s death. Of course, if the person who received the property held it for more than one year before selling it, the sale would get long-term treatment under the normal holding period rules.
Basis
Under the rule of Code § 1014(a), the basis of inherited property is ordinarily stepped-up (or down) to its fair market value as of the date of the decedent's death or alternate valuation date. The alternate valuation date is the date six months after a decedent's death, or if the property has been distributed within that six months, then the date of the distribution. (Code Sec. 1014(a); Code Sec. 2032) However, an alternate valuation date only applies if there is a taxable estate and using the alternate valuation results in a lower estate tax. (Caution: these rules do not apply to property inherited from an individual who died in 2010 if the “no estate tax” provision was elected by the executor – See Chapter 1.05).
Consistency Reporting
When an estate tax return is filed after July 2015, an estate and others who are required to file Form 706 must complete and file Form 8971 and its Schedule A to report the final estate tax value of property distributed or to be distributed from the estate. A copy of Schedule A must be provided to the beneficiary of the property. A beneficiary may not use a value higher than the value reported on Schedule A of Form 8971 as their initial basis in the property, and if the beneficiary reports a basis that is inconsistent with the amount reported on Schedule A, the beneficiary may be liable for a 20% accuracy-related penalty. The consistency in reporting applies only to property that was includible in the decedent’s gross estate and resulted in increased estate tax liability (reduced by applicable credits) on the estate. If a 706 is not required because the value of the estate is less than the lifetime exclusion amount, but is filed only to preserve the deceased spouse’s unused exclusion for the surviving spouse, Form 8971 is not required to be filed.
If no Federal estate tax return is required, an appraisal as of the date of the decedent's death for state inheritance or other transmission (e.g., legacy) taxes is used for basis purposes. In this situation, no alternate valuation date is used. These appraisals govern unless there is sufficient evidence of another value. (Reg § 1.1014-3(a))