A one-year scheduled repeal of the estate tax went into effect on Jan. 1 after lawmakers failed to reach a compromise on estate tax reform before year’s end. Repeal is a potentially adverse event for heirs of commercial real estate, however, because it also repeals “stepped-up basis” tax rules.
Under stepped-up basis, the tax basis is reset to reflect the fair market value of the property at the time of death. Under the carryover basis rules in effect during the repeal, the tax basis of inherited property is the same as the original owner’s basis, including any depreciation allowances claimed by the donor in prior years. As a result, estates that contain real property could often suffer more under full estate tax repeal than they would if the estate tax were preserved, because they will be subject to larger capital gains tax bills.
In 2010, capital gains tax will apply to appreciated assets above $1.3 million (or above $4.3 million for property transferred to a spouse). In 2011, the pre-2001 estate tax law will be reinstated ($1 million per person exemption, 55 percent tax rate, stepped-up basis tax rules).
Before Congress adjourned for 2009, the House of Representatives passed legislation (H.R. 4154) permanently extending the 2009 law ($3.5 million per person exemption and 45% tax rate) and preserving stepped-up basis, but the Senate was unable to pass an estate tax bill.
Senate supporters of more generous estate tax relief apparently felt that allowing the estate tax to expire (and rollover basis rules to go into effect) on Jan. 1 would give them more leverage to force a more generous compromise in early 2010. Some leading Senators are pushing for a lower 35 percent maximum rate with an increased $5 million exemption level.
Congress is expected to address estate taxes in 2010 as full repeal is unacceptable to proponents of the tax, and its “springing back” at the high 55 percent rate in 2011 is unacceptable to its opponents. The most likely outcome is compromise legislation with a tax rate of 35 percent to 45 percent and an exemption level of $3.5 million to $5 million.
It is unclear, however, whether any tax law change can be retroactively applied, as some legislators have said they intend to do. NAA/NMHC have long urged Congress to permanently extend the 2009 estate tax laws and to retain stepped-up basis tax rules.