According to folklore, an ancient Chinese curse is “May You Live in Interesting Times.” Certainly, it does not get more interesting than 2010 for estate planners. 2010 has brought many major, temporary changes at the federal level. 2010 has also brought several unique changes at a state level.
As I blogged about before, several states have overridden estate plans for decedents dying in 2010: https://www.aaepa.com/blog/2010/08/state-law-override-tax-benefits-bypass-trusts/.
2010 also may have a unique twist for state income taxes of decedents dying this year. Typically, states follow federal law with regard to income taxation rules. Section 1014(f) of the IRC provides that for federal income tax purposes the basis of property derived from a decedent is no longer derived by way of the step-up in basis rules. Instead, a modified carryover basis rule is applied. However, not every state will follow federal law in this regard. California, for one, is refusing to follow the federal lead in this regard. For California purposes, the basis of property of a decedent is determined without regard to IRC § 1014(f). See Cal. Rev. & Tax. Code §18035.6.
So, it will be necessary for a decedent’s attorney to keep two sets of basis records, one for California purposes and one for federal purposes.
Let’s look at an example. Decedent dies in 2010 with a single asset, a parcel of California real estate worth $5 million. The decedent purchased the property for $500,000 and made $200,000 of improvements over the years. So the basis immediately before death was $700,000. For federal income tax purposes the basis is $700,000 plus the executor allocates the $1.3 million of additional basis for a new federal income tax basis of $2 million for federal purposes. However, for California income tax purposes, the new basis is $5 million, i.e. the date of death value. The asset was inherited by Johnny who sells it in 2010 for $5 million. For California income tax purposes, Johnny has no gain. However, for federal purposes, Johnny has a gain of $3 million. For most other state income tax purposes, he would have a gain of $3 million.
This rule affects Californians who inherit property from a decedent dying in 2010. However, it may also affect non-Californians who inherit California property from a decedent dying in 2010. Basically, for California income tax purposes, the step-up will apply.
And you thought it couldn’t get any more complicated!
Stephen C. Hartnett, J.D., LL.M.
Associate Director of Education
American Academy of Estate Planning Attorneys, Inc.
6050 Santo Rd., Ste. 240
San Diego, CA 92124