What if someone dies on a weekend?
If there were no sales on the valuation date, figure the FMV as follows.
Find the mean between the highest and lowest selling prices on the nearest trading date before and the nearest trading date after the valuation date. Both trading dates must be reasonably close to the valuation date.
Prorate the difference between the mean prices to the valuation date.
Add or subtract (whichever applies) the prorated part of the difference to or from the mean price figured for the nearest trading date before the valuation date.
IRS Form 706 Instructions - Page 23
For step up on joint account between spouses in a non-community property state:
Morgan Stanley applies this by stepping up/down all the assets half way. They do not accept stepping up just half the assets.
Reg § 20.2031-2 explains that if a decedent dies on the weekend you would determine the FMV by taking straight average of Friday/Monday and it is not pro-rated.
Example (3). Assume the decedent died on Sunday, October 7, and that Saturday and Sunday were not trading days. If sales of X Company common stock occurred on Friday, October 5, at mean sale prices per share of $20 and on Monday, October 8, at mean sale prices per share of $23, the price of $21.50 is taken as representing the fair market value of a share of X Company common stock as of the valuation date
(1 X 20) + (23 X 1) / 2 =21.50
https://www.gpo.gov/fdsys/pkg/CFR-2012-title26-vol14/pdf/CFR-2012-title26-vol14-sec20-2031-2.pdf (page 2)
Joint Tenancy with Right of Survivorship
With this agreement you both have an equal share of the asset and when one of you dies the survivor automatically inherits the deceased's portion of the asset. With a JTWROS agreement the surviving "owner" won't need to go through the time consuming and expensive probate court process. A nice added benefit of JTWROS is that the deceased’s half of the asset will be given a step-up in cost basis, which will minimize the survivor's tax bill if he or she decides to sell the home.
I bet an example would help. Let's say you buy a home for $200,000 and you own it in JTWROS with your partner. So you each have a cost basis of $100,000. Now let's say that 30 years later the house is worth $800,000, when your partner passes. The deceased partner's cost basis becomes $400,000 while your cost basis stays at $100,000. So the new combined cost basis is $500,000 not $200,000. That's going to reduce your tax bill if you decide to sell the home.
Tenancy in Common
Tenancy in Common is a legal agreement where the co-owners do not automatically inherit the other person's share of the asset when there is a death. Basically you agree to own the asset together, but each of you names someone else as your beneficiary/heir. For example, you and a friend buy a condo together and own the property as a TIC. In your living revocable trust you stipulate that your mother, or cousin, or whomever you name, is to inherit your portion of the home. Not your co-owner.
TIC can make sense: if you remarry and want your children from a previous marriage to inherit your portion of a home bought with your new spouse, a TIC can be an effective way of making sure your kids inherit your share of the house.
Community Property
Community Property is a lot like JTWROS with one extra benefit. In the nine community property states (Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin) any asset you acquire with a spouse is considered to be equally-shared property. The added benefit is that when you own a home as community property the surviving spouse will receive a step-up in cost basis on the entire value of the home, not just the 50 percent that was the deceased spouse’s share of the asset. That said, the inheritance part of owning a home as community property can be a little stickier than with JTWROS; in some instances you may need to go through probate. Again, work with a good estate lawyer to see if there is a way to work around probate. In Arizona, Nevada, Texas and Wisconsin you can add a Right of Survivorship clause to your community property agreement which will ease the inheritance process.
How does Step-up work?
IRC 1014 describes it as the beneficiary’s basis is the FMV at date of death for property acquired from a decedent. When you inherit property, you generally receive an initial basis in property equal to the property's FMV. The FMV is established on the date of death or, sometimes, on an alternate valuation date six months after death. This is often referred to as a "stepped-up basis," since basis is typically stepped up to FMV. However, basis can also be "stepped down" to FMV.
Example: You purchased land for $25,000. It is now worth $250,000. You give the property to your child (assume the gift incurs no gift tax), who then has a tax basis of $25,000. If your child sells the land for $250,000, your child would have taxable gain of $225,000 ($250,000 sales proceeds minus $25,000 basis).
If, instead, you kept the land and transferred it to your child at your death when the land is worth $250,000, your child would have a tax basis of $250,000. If your child sells the land for $250,000, your child would have no taxable gain ($250,000 sales proceeds minus $250,000 basis).
What assets will receive step-up in basis at death of the owner?
Generally assets included in the decedent’s estate will receive a step-up in basis.
Exception – IRA, Annuity, Pension, 401K, Savings Bond, Stock options, Deferred compensation, Accrued salary, Net Unrealized Appreciation (NUA) of employer stock distributed from a qualified plan
Why isn’t there a step-up on IRA/Annuity /Pension/401k/Savings Bond?
These are all IRD (income with respect to decedent) items which are included in the decedents estate and do not receive a step up. However, the estate tax attributable to the built in gain is a Misc. Itemized not subject to 2% floor of AGI for the beneficiary or estate (whoever includes in income). This is an attempt to offset the double taxation at the estate and beneficiary level, but not even close to a perfect offset. The executor preparing a decedents final return can elect to include the built in gain on the Savings Bond on the return. If this is true, then the basis for the beneficiary is the FMV at the time of death.
How does it work with NUA?
If there is estate tax attributable to the NUA the beneficiary is entitled to the IRD deduction to offset the double taxation. There a special modification necessary to not get a double benefit of reduced rate long term capital gain and an itemized deduction against ordinary income.
http://www.irs.gov/pub/irs-pdf/p559.pdf pages 9-11
https://www.irs.gov/pub/irs-pdf/i1040sca.pdf page 12
1. How does Step-up work in specific titled accounts?
Single Account: All individual titled assets owned by the decedent receive a 100% step-up/down to the average of the high and the low on the date of death.
http://www.irs.gov/pub/irs-pdf/i706.pdf page 13
Joint tenants with right of survivorship (JTWROS) Account:
Are the owners spouses?
Yes->
Community property state? (AZ, CA, ID, LA, NV, NM, TX, WA WI)
-> 100% step up http://www.irs.gov/pub/irs-pdf/p555.pdf page 8
All other states?
-> 50% step up on all shares (the adjusted basis to the surviving spouse is the average of the date of death value and the original cost)
No->
Step up is based on portion attributable to the decedent. A similar methodology is applied as to the step on the non-community JTWROS spouses. The percentage of assets attributable to the decedent multiplied times the built in gain plus the original cost will be the surviving tenants basis on all the shares.
http://www.irs.gov/pub/irs-pdf/f706.pdf page 13 IRC 2040(b)
Joint tenants in common (JTIC) Account: The specific assets that revert to the decedent’s estate will receive a 100% step-up to the average of the high and the low on the date of death.
How does ½ step-up for joint account between spouses in a non-community property state work? Or the partial step-up for joint account between non-spouses?
No clear guidance under current tax law on how it should be done, the two ways that UBS will accept:
For spouses ->
a. Stepped-up to FMV on half of the assets
Example. 100 shares of ABC in joint account between spouses in non-community state, adjusted basis was $10/share, husband dies, FMV on date of death was $20/share. Wife inherited the 100 shares, she will have 50 shares with basis of $10 and 50 shares with basis of $20.
b. Stepped-up on all the assets half way to FMV
Example. 100 shares of ABC in joint account between spouses in non-community state, adjusted basis was $10/share, husband dies, FMV on date of death was $20/share. Wife inherited the 100 shares, she will have 100 shares with basis of $15
For non-spouses where decedent had 30% contribution->
c. Stepped-up to FMV on 30% of the assets
Example. 100 shares of ABC in joint account between non-spouses, adjusted basis was $10/share, decedent dies, FMV on date of death was $20/share. Beneficiary inherited the 100 shares, he will have 70 shares with basis of $10 and 30 shares with basis of $20.
d. Stepped-up on all the assets 30% to FMV
Example. 100 shares of ABC in joint account between non-spouses, adjusted basis was $10/share, decedent dies, FMV on date of death was $20/share. Beneficiary inherited the 100 shares, he will have 100 shares with basis of $13
3. What is the definition of FMV? What happens if the decedent passed on a weekend?
The value of a gift is the fair market value (FMV) of the property on the date the gift is made (valuation date). The FMV is the price at which the property would change hands between a willing buyer and a willing seller, when neither is forced to buy or to sell, and when both have reasonable knowledge of all relevant facts. FMV may not be determined by a forced sale price, nor by the sale price of the item in a market other than that in which the item is most commonly sold to the public. The location of the item must be taken into account whenever appropriate.
The FMV of a stock or bond (whether listed or unlisted) is the mean between the highest and lowest selling prices quoted on the valuation date. If only the closing selling prices are available, then the FMV is the mean between the quoted closing selling price on the valuation date and on the trading day before the valuation date.
If there were no sales on the valuation date, figure the FMV as follows:
1. Find the mean between the highest and lowest selling prices on the nearest trading date before and the nearest trading date after the valuation date. Both trading dates must be reasonably close to the valuation date.
2. Prorate the difference between the mean prices to the valuation date.
3. Add or subtract (whichever applies) the prorated part of the difference to or from the mean price figured for the nearest trading date before the valuation date.
Example: If the average on Friday was 10 and the average on Monday is 13, then Saturday will be 11 and Sunday will be 12. Think incrementally.
http://www.irs.gov/pub/irs-pdf/i709.pdf pages 9-10
4. When can Alternate Valuation date be used to determine the basis for inherited assets?
The property included in the alternate valuation and valued as of 6 months after the date of the decedent's death, or as of some intermediate date is the property included in the gross estate on the date of the decedent's death. Therefore, you must first determine what property was part of the gross estate at the decedent's death.
Alternate valuation cannot be applied to only a part of the property. You may not elect alternate valuation unless the election will decrease both the value of the gross estate and the sum (reduced by allowable credits) of the estate and GST taxes payable by reason of the decedent's death for the property includible in the decedent's gross estate.
Once made, the election may not be revoked. The election may be made on a late-filed Form 706 provided it is not filed later than 1 year after the due date (including extensions actually granted). Relief under Regulations sections 301.9100-1 and 301.9100-3 may be available to make an alternate valuation election or a protective alternate valuation election, provided a Form 706 is filed no later than 1 year after the due date of the return (including extensions actually granted).
http://www.irs.gov/pub/irs-pdf/i706.pdf page 10