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Navigating Estate Basis Consistency Reporting Requirements for Inherited Property by Sarah Gaymon, CPA

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Posted on May 30, 2023 by Sarah Gaymon

Whether you are the executor of a decedent’s estate or a beneficiary named to receive the assets of a person who has passed away, it is critical you understand your responsibility to report the tax basis of inherited property consistently with the fair market value on the date of death. Failure to do so can result in additional tax liabilities for both the estate and the beneficiaries as well as penalties equal to 20 percent of the portion of the underpayment attributable to the inconsistent basis reporting.

Generally, the estate tax applies when the gross value of a decedent’s assets plus lifetime gifting exceeds the federal estate tax exemption, which, for 2023, is $12.92 million, or $25.84 million for married couples utilizing portability or joint lifetime gifting. Making this determination requires an accounting of everything the decedent owned (or held an ownership interest in), assessing that property at the fair market value (FMV) on the date of the decedent’s death and adding the decedent’s lifetime gifts exemption used during life. When the value of the estate at that time is more than the tax-filing threshold, an estate tax return must be filed (IRS Form 706 or 706-A), and taxes must be paid at an approximate 40 percent tax rate. The executor of the estate is generally the one responsible for ensuring this filing obligation is met.

Beneficiaries receiving assets from an estate generally have an obligation to report the basis of inherited property when selling that property in the future to determine if there is a gain at the time of sale. Under Internal Revenue Code Section 1041, inherited property receives a step-up in basis to its FMV on the date of the decedent’s death. To do this properly, the executor should provide the value of the estate assets distributed to beneficiaries, otherwise, beneficiaries would not be able to report gains when they ultimately dispose of the property. For this reason, the IRS believes taxpayers have opportunities to game the tax laws to their advantage by undervaluing assets for the purpose of reducing estate taxes or artificially inflating the value of property passed onto beneficiaries in an effort to reduce future capital gains tax.

To prevent these abuses, Internal Revenue Code Section 6035 requires consistent reporting between a property’s basis as reported on an estate tax return and the basis reported by the beneficiary to calculate a gain when he or she sells that property. Currently, the executor filing an estate tax return for a taxable estate, must also furnish to the IRS and each beneficiary receiving property from the estate  Form 8971, Information Regarding Beneficiaries Acquiring Property From a Decedent, along with Schedule A detailing the estate tax value of property acquired by the beneficiaries on the date of the original owner’s death and whether or not the asset contributed to the estate tax. These documents must be furnished within 30 days after the estate tax return was due (including extensions) or 30 days after the return was actually filed, whichever occurs sooner.

Should the property value reported on Schedule A later change, the executor must file supplemental Forms 8971 and provide updated Schedules A to each affected beneficiary no later than 30 days after the valuation adjustment. These forms essentially create a paper trail to ensure that a property’s estate tax value is the same as the basis reported by the person who inherits that property.

An inherent problem still exists within these rules, as many decedents pass away with asset values well below the estate tax return filing obligation, yet the basis consistency rules still apply. In this scenario, Form 8971 filing is not required. Additional examples that exempt a Form 8971 filing include situations in which the estate tax return is filed solely to make an allocation or election respecting the generation-skipping transfer tax, or the estate tax return is filed solely to elect portability of the deceased spousal exclusion amount (DSUE.) In these situations, the executor is still required to determine asset values on the date of death, and furnish support for the date of death value to the beneficiaries unless a specific exemption applies.

Executors and beneficiaries of decedents’ estates often have a hard road ahead of them. Finding the strength to balance their time of grief with their legal responsibilities to properly value estate assets and file required reports and ensure the final wishes of the deceased are met, can be challenging. It is highly recommended that any executor administering an estate work with a qualified trusted advisor to ensure all obligations are met, and hopefully, make the grieving process a bit easier.

About the Author: Sarah Gaymon, CPA, is an associate director of Tax Services with Berkowitz Pollack Brant Advisors + CPAs, where she works with entrepreneurs and high-net-worth families to plan for tax-efficient wealth preservation and multi-generational wealth transfers.  She can be reached at the CPA firm’s West Palm Beach, Fla., office at (561) 361-2050 or info@bpbcpa.com.