Good news for surviving spouses with pre-1977 property.

Given today's quick change society, tax advisers tend to forget that many of their older clients bought homes years ago and never moved. If the home (or any other real estate) was purchased before 1977 and was held jointly by the spouses, when one spouse dies, certain possibilities or problems could occur.

Background

Under Sec. 2040(b)(1), one-half of the fair market value (FMV) of any property jointly owned by spouses is included in the decedent's estate. The surviving spouse takes a basis step-up on that half under Sec. 1014, while retaining one-half of the original basis. This applies regardless of which spouse's funds were used to make the original purchase.

However, in Gallenstein, 975 F2d 286 (6th Cir. 1992), the Sixth Circuit ruled that a surviving spouse was entitled to the full basis step-up on real estate purchased before 1977 and held jointly with the decedent spouse, even though the surviving spouse had not contributed to the property's original purchase.

Facts

In Gallenstein, a husband and wife jointly purchased a farm in 1955 with the husband's earnings. In 1987, the husband died. In 1988, the surviving spouse, now the sole owner of the farm, sold some acres. In a second amended return for 1988, she claimed the full sales price as her adjusted basis in the property, based on an amended estate tax return that included 100% of the property in the estate valuation. The IRS denied her claim based on Sec. 2040(b)(1).

Before 1977, under Sec. 2040, a decedent's estate included 100% of jointly owned property, unless the survivor could prove contribution. Sec. 2040 was amended in 1976, 1978 and 1981, so that Sec. 2040(b) reads as it currently does. In Gallenstein, the court ruled that the 100% inclusion portion of Sec. 2040 had not been repealed, as had other subsections; thus, property acquired before 1977 still qualified for total inclusion.

The inclusion of 100% of the FMV of the property in the estate of the first spouse to die does not result in any immediate Federal estate tax, because property can pass between spouses with an unlimited marital deduction, under Sec. 2056. At the same time, it would give the surviving spouse a 100% basis step-up, avoiding capital gain if the property were to be sold.

After Gallenstein, two more causes strengthened this advantage--Patten, 116 F3d 1029 (4th Cir. 1997), and Anderson, DC MD, 5/29/96. Notable in both cases was the fact that no amended estate tax returns were filed.

Gallenstein, Patten and Anderson all applied to real estate. In Hahn, 110 TC 140 (1998), the Fourth Circuit extended similar treatment to stock in a cooperative apartment building purchased before 1977.

Open Questions

Gallenstein and similar cases can be highly advantageous to those who qualify. But what if the surviving spouse was the contributor? Gallenstein would definitely not be advantageous to the survivor; current Sec. 2040 would be.

Gallenstein and similar cases have set precedent in both the Fourth and Sixth Circuits. There have been other cases in district courts in other circuits. However, the instructions to Form 706, United States Estate (and Generation-Skipping Transfer) Tax Return, say to include one-half of the FMV, regardless of contributions or date acquired.

When a client dies, it is important to ask who, what and when. If the answers are contributor, real estate and pre-1977, Gallenstein could provide substantial savings.

KAREN DEDERYAN, GRAY, GRAY & GRAY, LLP, WESTWOOD, MA