By Lauren Y. Detzel, Matthew J. Ahearn and Brian M. Malec
This post kicks off our review of Revenue Procedure 2011-41, which was released simultaneously with IRS Notice 2011-66. Rev. Proc. 2011-41 provides optional safe harbor guidance regarding basis issues under section 1022 for estates of decedents who died in 2010. It’s important to note that Rev. Proc. 2011-41 is merely a safe harbor. It does not limit how section 1022 may be applied and, in fact, Rev. Proc. 2011-41 does not address several issues arising from the language of section 1022. If an executor follows the guidance in Rev. Proc. 2011-41 and does not take any contrary return positions, Rev. Proc. 2011-41 states that the IRS will not challenge the taxpayer’s ability to rely on the Revenue Procedure either on Form 8939 or any other return of tax.
It is important to understand that section 1022 applies to determine a recipient’s basis in property acquired from a decedent; however, the basis increase afforded under sections 1022(b) and (c) can only be allocated to property which is also owned by the decedent. Certain property may be acquired from a decedent, but not owned by the decedent. Therefore, although section 1022 will apply to determine the basis of property acquired from a decedent, it is possible that basis increase cannot be allocated to such property.
The phrase “acquired from” generally refers to property acquired by bequest, devise or inheritance, or by the decedent’s estate from the decedent. It also refers to property (1) transferred by a decedent to a qualified revocable trust (as defined in section 645), (2) transferred by a decedent to any other trust in which the decedent reserved the right to change the enjoyment through a power to alter, amend or terminate the trust, or (3) passing from the decedent by reason of death to the extent such property passed without consideration. If property is treated as being acquired from a decedent, then the recipient’s basis in such property will be the lesser of the adjusted basis of the decedent or the fair market value at the decedent’s death. Rev. Proc. 2011-41 clarifies that property acquired from a decedent will have a section 1022 basis, regardless of when the property is actually sold, if the section 1022 election is made by the executor.
Rev. Proc. 2011-41 provides that the following types of property are treated as being acquired from a decedent:
(i) Any property transferred at a decedent’s death by reason of the decedent holding and/or exercising a general power of appointment (if the power was not created by the decedent);
(ii) property held by the decedent and another as joint tenants with right of survivorship or as tenants by the entirety; and
(iii) the surviving spouse’s one-half interest in community property.
Additionally, Rev. Proc. 2011-41 specifically provides that property held in a QTIP trust which passes as a result of a decedent’s death is NOT treated as property acquired from the decedent. Thus, the recipient’s basis in the QTIP property is not determined under section 1022 and basis increase cannot be allocated to QTIP property. Because section 1022 does not apply to QTIP property, the basis of QTIP property will carry over to the recipient and not be affected by the decedent’s death if the executor makes the section 1022 election.
On the other hand, the phrase “owned by” the decedent generally refers to property legally titled in the name of the decedent at death, plus certain additional property which falls within the ownership rules set forth under section 1022(d)(1). Rev. Proc. 2011-41 clarifies that property owned by a decedent includes property owned in a decedent’s qualified revocable trust at the decedent’s death, regardless of whether a section 645 election is actually made for such trust. Rev. Proc. 2011-41 also provides the following ownership rules:
(i) Property transferred to a trust over which the decedent retained a power to alter, amend or terminate (unless it is a qualified revocable trust under section 645) is not treated as owned by the decedent;
(ii) Property over which the decedent holds any power of appointment is not treated as owned by the decedent at death;
(iii) property transferred to a trust in which the decedent retained an income interest is not treated as owned by the decedent solely by reason of the retained income interest; and
(iv) property transferred to a foreign trust by a U.S. grantor is not treated as owned by the decedent solely by reason of the decedent being treated under section 679 as the grantor of such property.
Rev. Proc. 2011-41 also contains a savings clause-type provision with respect to property held in trust which provides that, even though certain property in trust may not be treated as owned by the decedent under the rules above, such property will nevertheless be deemed to be owned by the decedent if the terms of the trust require the trust property to revert back to the decedent upon death. For example, property included in a QPRT or GRAT would generally not be deemed to be owned by the decedent (and therefore basis increase could not be allocated) unless the QPRT of GRAT provides that the property is to be distributed to the decedent’s estate if the decedent dies prior to the expiration of the trust term.
Notwithstanding the above, certain property that is treated as being acquired from and owned by the decedent may not be eligible to receive basis increase. Rev. Proc. 2011-41 reiterates that property acquired by the decedent by gift within 3 years prior to death cannot receive basis increase unless such gift was made by the decedent’s spouse and such spouse did not receive the property by gift within 3 years of the decedent’s death. Additionally, basis increase cannot be allocated to stock or securities of a foreign personal holding company, a domestic international sales corporation (DISC) or former DISC, a foreign investment company, or a passive foreign investment company, unless such company is a qualified electing fund as defined in section 1295 with respect to the decedent.
It is imperative to understand the rules for determining property “acquired from” a decedent and property “owned by” a decedent in completing Form 8939. In our upcoming posts, we will dive into the remaining aspects of Rev. Proc. 2011-41, which include rules for determining the amount of basis increase, making allocations and determining the fair market value and holding period of assets to which section 1022 applies.