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Survivor's basis in jointly-held property.

In the past several months, numerous practitioners have asked the author some variation of the following question: "After one joint tenant dies, what is the survivor's basis in the property?" These queries have come from lawyers, certified public accountants and certified financial planners. This apparent dearth of knowledge regarding the survivor's basis led to this article.

Types of Joint Ownership

Before the survivor's basis can be determined, the type of joint tenancy must be ascertained. The three common forms of joint tenancies are: tenancy in common, joint with rights of survivorship and tenancies by the entirety. With a "tenancy in common," when one of the joint owners dies the decedent's interest passes via his will.

Example 1

Tom and Jerry are brothers. They own a hunting cabin as tenants in common. Tom dies, and his will provides that his interest in the cabin goes to his son Bob. Now, Bob and Jerry are tenants in common.

On the other hand, if the property is held "joint with rights of survivorship," when one joint owner dies the other joint owner (or owners) takes the decedent's interest by operation of law. As to such interest, the decedent's will and the related probate proceedings are irrelevant.

Example 2

Tom and Jerry are brothers. They own a hunting cabin together with the deed containing the words "joint with rights of survivorship." Tom dies and his will leaves his interest in the cabin to his son Bob. In this case, the title overrides the will provision and, therefore, Jerry is now the sole owner of the cabin.

The last form of joint tenancy is called "tenancy by the entirety." This form of joint tenancy exists only between spouses. Whether spouses own property titled "joint with rights of survivorship" or as "tenants by the entirety," the rules pertaining to the survivor's basis are the same; thus, in this article, spousal joint with rights of survivorship will be treated as synonymous with tenancies by the entirety. Also, for the sake of brevity, if the joint ownership has a survivorship element, it will be referred to as "joint tenancy," and if it doesn't, it will be referred to as "tenancy in common."

Section 1014 Basis Rules

Internal Revenue Code Section 1014(1) provides the basis rules for taxpayers that receive property from a decedent. Under this section, the recipient takes a basis equal to the property's fair market value at the date of death.(2) This rule is easily understood when the decedent is the sole owner of the asset.

Example 3

When Mr. Dodge died, he owned $100,000 worth of GM stock. Pursuant to his will, Mrs. Dodge inherited this stock. Her basis in the stock is $100,000.

When property is owned jointly, however, arriving at the survivor's basis is much more complicated. That is, since Sec. 1014 only applies to property acquired from a decedent,(3) the issue to be resolved is: What portion of the property did the survivor acquire from the decedent?

Sec. 1014 answers this question by providing that property included in the decedent's gross estate is considered to have been acquired from the decedent.(4) This is true whether or not a federal estate tax return (i.e., Form 706) is required to be filed.(5)

This leads to a second issue: What portion of the jointly-held property is included in the decedent's gross estate? The following segments of this article delve into this issue.

Spousal Joint Tenancies

It is axiomatic that with spousal joint tenancies, one-half of the date of death value of the property is included in the estate of the first spouse to die.(6) Given this immutable rule, the survivor's basis would be determined as shown in the following example.(7)

Example 4

Mr. and Mrs. Doe own their house in joint tenancy. Immediately before Mr. Doe's death, the basis of the house is $43,000, but it is worth $102,000. At the date of Mr. Doe's death, Mrs. Doe's basis would be:
Basis of 1/2 acquired from Mr. Doe
(1/2 x $102,000) $51,000


Basis of the 1/2 not acquired from Mr. Doe
(1/2 x $43,000) 21,500


Mrs. Doe's basis after Mr. Doe's death $72,500


To continue this example, assume that Mrs. Doe sells the house and moves away. If she sells it for its $102,000 value, she will have a gain of $29,500 (i.e., $102,000 - $72,500). This is considered to be a long-term capital gain.(8) However, the tax on this gain could be deferred or avoided entirely if one of the special "sale of a residence" provisions of the law applies.(9)

For property that had been depreciated prior to death, a downward adjustment to the basis is required for the survivor's share of the accumulated depreciation.(10)

Example 5

Assume that the house in Example 4 is a rental house, and that at the time of Mr. Doe's death the accumulated depreciation on the house is $15,000. Further, assume that state law provides that joint tenants share equally in the joint property's income and expenses. Now, Mrs. Doe's basis immediately after Mr. Doe's death would be:
Basis of 1/2 acquired from Mr. Doe
(1/2 x $102,000) $51,000


Basis of the 1/2 not acquired from Mr. Doe
(1/2 x $43,000) 21,500


Less: Mrs. Doe's share of accumulated
depreciation (1/2 x $15,000) (7,500)


Mrs. Doe's basis after Mr. Doe's death $65,000


This "one-half inclusion rule" for spousal joint tenancies is simple compared to the inclusion rule for non-spousal joint tenancies, which is covered next.

Nonspousal Joint Tenancies

For nonspousal joint tenancies, the entire value of the property is included in the estate of the first joint tenant to die unless the decedent's estate can prove that the survivor provided some consideration for his interest.(11) The following example illustrates a probate avoidance technique that seems to be occurring quite frequently.

Example 6

Mrs. M, a widow, purchased her house in the 1960s for $29,000. In order to avoid probating the house, she executed a deed which named her and Mr. S, her son, as a joint tenant. The son did not provide any consideration for his ownership interest. At the date of Mrs. M's death, the house was worth $150,000. Mr. S (now the sole owner) doesn't need the house and has received a $157,000 purchase offer. He wants to know the amount of taxable gain that would result from the sale.

The answer, of course, depends on Mr. S's basis in the house. Since he provided none of the consideration, the entire $150,000 value of the house was included in his mother's estate; therefore, Mr. S takes a $150,000 basis, and his gain on sale would be $7,000 (i.e., selling price of $157,000 less $150,000 basis).(12)

In the foregoing example, the survivor did not provide any consideration for his interest. In the situation where the survivor does provide consideration, the law is vague as to the value to include in the decedent's estate. The following example uses the pro rata inclusion approach, which appears to be required by the regulations.(13)

Example 7

In Example 6, assume that, prior to Mrs. M's death, Mr. S paid $8,000 for a furnace, air conditioning and a new roof; thus, Mr. S provided $8,000 of the $29,000 pre-death basis.(14) In this case, under the pro rata method, only $108,621 of the $150,000 value would be included in Mrs. M's gross estate, computed as follows: $150,000 [($8,000/$29,000) x $150,000] = $108,621

Thus, Mr. S's basis after Mrs. M's death apparently would be:
Basis of interest acquired from Mrs. M $108,621


Basis of interest not acquired from Mrs. M 8,000


Mr. S's basis after Mrs. M's death $116,621


In the Peters case, the 4th Circuit Court of Appeals, affirming the Tax Court, refused to apply the pro rata formula of the regulations; instead, the court excluded only the survivor's actual contribution.(15) Thus, applying the Peters case to the facts of Example 7, the 4th Circuit would only exclude $8,000 from Mrs. M's estate. Mr. S's post-death basis then would be the entire $150,000 value of the property (i.e., $142,000 included in Mrs. M's estate + $8,000 Mr. S's contribution).

Commentators have opined that, theoretically, the excluded amount should be a hybrid of the regulations and the Peters case. Specifically, they say the excluded amount should be the sum of the survivor's contribution and any appreciation attributable thereto.(16) But until either Congress clarifies the law or the Treasury clarifies its regulations, or until the issue is taken before United States Supreme Court, this contribution rule will remain nebulous.

For depreciable property, the downward basis adjustment which was illustrated above under "Spousal Joint Tenancies" (see Example 5) also applies to non-spousal joint tenancies. Specifically, the survivor must reduce his post-death basis by his share of the pre-death accumulated depreciation.

Tenancies in Common

Thankfully, the tenancy in common inclusion rule is an easy one. Simply divide the date of death value of the property by the number of joint owners and include the resultant value in the decedent's estate.(17) Whoever inherits this interest will, accordingly, take a basis equal to that value.

Example 8

Years ago Moe, Larry and Curley bought 500 acres of vacant land for $120,000, taking title as tenants in common; at the date of Moe's death, the land was worth $600,000. Moe left his interest in this land to his good friend Shemp. Moe's gross estate would include his one-third interest at a value of $200,000, and Shemp's basis would, likewise, be $200,000.

Income in Respect of a Decedent

The Sec. 1014 basis rules explained above do not apply to income in respect of a decedent property.(18) Such property has a built-in income feature. Common examples include U.S. Government Series EE bonds that contain unrecognized interest income and installment notes receivable that contain unrecognized gain.

While full coverage of this topic is beyond the scope of this article, the following example will illustrate the basis rules for Series EE bonds.(19)

Example 9

Years ago Mr. and Mrs. Smith bought Series EE bonds as joint tenants for $20,000. They elected to defer recognition of the interest income until maturity. At the date of Mr. Smith's death these bonds are still outstanding and have a value of $37,000. Under the "income in respect of a decedent" rule, Mrs. Smith (now the sole owner) must retain the original $20,000 basis.

Conclusion

This article was written to aid practitioners in calculating the survivor's basis in jointly-held property. To that end, the author suggests that the reader keep this article in a convenient location and refer to it as questions in this area arise.

Footnotes

1 All references to the Internal Revenue Code are to the Internal Revenue Code of 1986. Hereinafter, the abbreviation "Sec." will be used to refer to this code.

2 Sec. 1014(a)(1). If the Section 2032 alternate valuation date is elected by the decedent's executor, Section 1014(a)(2) provides that the recipient will use that value as the basis of the property; or, if the special use valuation rule of Section 2032A is elected, Sec. 1014(a)(3) provides that the recipient will use that value as the basis of the property. For brevity sake, this article assumes that no such elections were made. Thus, all references will be to the "fair market value at date of death."

3 Sec. 1014(a). Technically, the language is "...acquiring the property from a decedent or ...the property passed from a decedent..."

4 Sec. 1014(b)(9).

5 Treasury Regulation 1.1014-2(b)(2). Hereinafter, the abbreviation "Reg. Sec." will be used to refer to these regulations.

6 Sec. 2040(b).

7 See IRS Publication Number 551, Basis of Assets, "Qualified Joint Interests."

8 Sec. 1221 provides, by default, that the house is a capital asset; that is, since a person's house is not one of the assets listed in this section, it is a capital asset. Sec. 1223(11) and Reg. Sec. 1.1223-1 (j) provide that property acquired from a decedent is automatically considered to be held for more than one year (i.e., "long-term"). Further, Sec. 1(h) provides for a 28% maximum tax on net long-term capital gains.

9 See Secs. 121 and 1034.

10 Sec. 1014(b)(9), Reg. Sec. 1.1014-6(a), and IRS Publication 551 (see note 7 above).

11 Sec. 2040(a). Reg. Sec. 20.2040-1(a)(2) implies that consideration includes capital improvement costs. Also, the Peters case (see note 15 below) included capital improvement costs as consideration. Note, if the joint owners acquired their interest by gift or inheritance, Sec. 2040(a) and Reg. Sec. 20.2040-1(a)(1) require the inclusion of only a pro rata portion of the value of the property in the estate of a deceased joint tenant.

12 This $150,000 date of death basis results whether or not Mrs. M's estate filed a federal estate tax return (Form 706). See note 5 above.

13 Reg. Sec. 20.2040-1(a)(2).

14 Capital improvement costs are treated as consideration. See note 11 above.

15 Estate of Peters v. Comm'r, 386 F2d 404 (4th Cir. 1967), affirming 46 TC 407 (1966). In order to prevent a potential abuse, the court refused to apply the regulations literally. To illustrate this abuse, assume in Example 7 that Mrs. M's estate is large enough to be subject to the federal estate tax and that Mr. S expended the $8,000 for improvements just before Mrs. M's death.

If the regulations were applied literally, Mr. S's $8,000 expenditure would have removed $33,379 in value from his mother's taxable estate, i.e.:
Value of house included in Mrs. M's taxable
estate if Mr. S had not made the capital
improvement $142,000


Value of house actually included in Mrs. M's
taxable estate because Mr. S did make the
capital improvement (see calculation in
Example) 7,108,621


Reduction in Mrs. M's taxable estate $ 33,379


If Mrs. M's estate is in the 37% tax bracket, Mr. S's capital expenditure of $8,000 (for which equivalent value was wrought into the house) would have saved over $12,000 in estate taxes.

Note, however, if the estate is not large enough to be subject to tax, the survivor benefits from the Peters decision by receiving a greater basis than the pro rata approach would have yielded $150,000 under Peters and $116,621 under the regulations.

Also, along these lines, the 7th Circuit Court of Appeals in Madden v. Commissioner, 440 F2d 784 (1971), states that the exclusion is not elective, meaning that the estate cannot elect to ignore the survivor's contribution and include the entire value of the joint property in order to give the survivor a greater basis. The court reasoned that this would violate the intent of Congress.

16 Stephens, Federal Estate and Gift Taxation, 6th Edition (Warren, Gorham & Lamont), page 4-302; Beausang, Jr., Jointly Owned Property, 131-3d (Bureau of National Affairs Tax Management Portfolios), page A-21, fn. 199.

17 Reg. sec. 20.2040-1(b) states that sec. 2040 "has no application to property held by the decedent and any other person (or persons) as tenants in common." Sec. 2033 states: "The value of the gross estate shall include the value of all property to the extent of the interest therein of the decedent at the time of his death." In Harvey Estate v. U.S., 185 F2d 463 (1950), the 7th Circuit Court of Appeals ruled that a pro rata portion of property held as tenancy in common was included in the decedent's estate.

18 Sec. 1014(c) and Reg. Sec. 1.1014-1(c)(1) provide that the Sec. 1014 "value at date of death" basis rules do not apply to property representing income in respect of a decedent (IRD). Also, the Sec. 1223(11) automatic long-term holding period referred to in note 8 above does not apply to IRD property.

19 Reg. Sec. 1.691(a)-2(b), Example 3 illustrates the inclusion of deferred interest in the survivor's income.

William D. Hood, JD, CPA, MS, is a professor at the Central Michigan University School of Accountancy in Mt. Pleasant.
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Author:Hood, William C.
Publication:The National Public Accountant
Date:Oct 1, 1995
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