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Have Your Cake and Eat It Too:
Part Deux—The New Tax Act
By Peter Stern, Esq.


Like the phoenix from the ashes, step up in basis, the life estate, and IRC Sections 2001-2210 have leapt back to life, with retroactive application for decedents dying from January 1 to December 31, 2010.

The “Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010,” passed by Congress on December 17, 2010, wiped away all doubts about being able to use our favorite recovery avoidance devices for decedents who died in 2010.

As I noted in the first part of this article, in the summer 2010 Net News, we were resigned to following what was new Section 1022 of the Code, which provided for carry over basis and created two aggregates for basis increase: a general one for $1,300,000 and a spousal aggregate basis increase of $3,000,000. With the repeal of Section 2036 last year, we lost the ability to use the occupancy agreement and the life estate to pull the residence back into the estate of the decedent to obtain a step up. Instead, to qualify for the basis increase exceptions, we had to rely on use of trusts to which the decedent had transferred property while alive and where the decedent had the right “to make any change in the enjoyment thereof through the exercise of a power to alter, amend, or terminate the trust.”

But where the decedent had used a life estate or occupancy agreement and then died in 2010, until Congress and the President acted in December, our clients were out of luck with regard to a step up in basis.

The December bill made EGTRRA go away. Section 301(a) boldly proclaimed: “Each provision of law amended by subtitle A or E of title V of [EGTRRA] is amended to read as such provision would read if such subtitle had never been enacted.” This is as close as Congress can get to unringing a bell. Section 2036 is back in place; property in which a decedent had reserved a life estate comes back into the estate for estate tax purposes, and under newly revived Section 1014 gets a full step up in basis. So much for persons who died after enactment.

Better was yet to come: Section 301(c) permits executors to apply the law as if EGTRRA had not been adopted for decedents who died in 2010! So those life estates and occupancy agreements were still good—retroactively—as planning devices! And the deadline for filing to take advantage of these changes when an estate tax return would be due was set at not earlier than nine months after the enactment date of the Statute, or September 2011.

The IRS has tinkered for several months with a procedure for applying the carryover rules to 2010 decedent estates, and just last month issued a memorandum about Form 8939, “Allocation of Increase in Basis for Property Acquired from a Decedent,” and a revised draft form available at www.irs.gov/uac/Form-8939,-Allocation-of-Increase-in-Basis-for-Property-Acquired-From-a-Decedent. If you elect to proceed under the 2011 law, you would not have any filing requirements so long as the decedent’s estate was under the estate tax threshold amount. Simply have the property appraised as of date of death to determine basis to be claimed at the time of an eventual sale.

And where does this leave us now?

1. We can still use the economical approach of having our Medi-Cal beneficiaries deed away a remainder interest while reserving a life estate. So long as the deed is irrevocable, the gift will escape recovery and qualify for a step up in basis.

2. Since the analysis of the occupancy agreement remains the same as it was prior to 2010, the use of the occupancy agreement should also retain its benefits: avoidance of recovery and step up in basis.

3. And for those practitioners who use the intentionally defective grantor trust, it will no longer be necessary to split hairs in analysis of Section 1022 as it was in EGTRRA to determine whether or not such trusts pass muster as devices that will permit a step up in basis: if the trust remains a grantor trust, there will be a step up in basis.

The tax act itself is rich in planning opportunities: portability of the higher $5 million exemption amount; a new unified tax for gift, generation skipping, and estate tax purposes; and a 35% tax rate. It’s not hard to figure out who won the elections last fall. For our clients on Medi-Cal, we have the security of knowing that at least for the next two years our planning devices will work. And while we don’t know what will happen after January 1, 2013, at least we know that there will not be an automatic default back to EGTRRA—we may lose our $5 million exemption, but we will still have Section 2036 even if the current law lapses.

(Peter S. Stern, Esq., is an attorney in private practice in Palo Alto, CA)