Estate 1041 & rental property

[joanmcq]

I'm doing my first estate return in ages, and this one has a rental. So depreciation. Do I calculate depreciation at the same rate as the decedent's return, or does the step up in basis begin on the estate return? I'm probably overthinking this but this is the first estate I've done that's had anything other than a personal residence. And this one has probate in 3 states, so it's been taking a while to close.

[kcjenkins]

What type of trust?

[jklcpa]

Joan, it wasn't held in a trust prior to death, was it? That may change my answer, but I believe if the property was titled in the individual name, then  you would use the stepped up basis and depreciation starts over in the estate, covered by IRC 1014(a), I think. If the deceased was the sole owner, any depreciation taken by the estate before death is ignored at the time of disposition, so if the estate continues to rent and depreciate, the basis at disposition would be the FMV at DOD (or the alternate valuation date) less any depreciation taken by the estate. It is more complicated if the property was not solely owned because the other owner(s) continue on with their original basis and depreciation, and they may or may not be the person or entity that inherits the property. Community property states also complicate a situation where property is co-owned.
 
Below is some narrative and an example that may help:
 

Depreciable Assets

Depreciation is one of the “events” that affects basis; when a taxpayer has recovered part of his or her investment through a depreciation deduction, the basis must be reduced by the amount of the deduction. However, if you inherit property that the decedent had been depreciating (because he or she had used it in a business or rental activity), the inherited basis of the property may or may not be affected by the prior depreciation that was claimed. If the decedent was the sole owner of the property and died prior to 2010, the inherited basis is the full fair market value at the date of death (or the alternate valuation date, if applicable) – that is, no adjustment is required for the depreciation allowed while the decedent was alive. The inherited basis from decedents dying in 2010 is determined by a more complicated set of rules (see CAUTION 2010 earlier in this article). If the property continues to be used for business or rental purposes, depreciation starts anew based upon the inherited basis.

As explained above under “Beneficiary Tax Basis,” when the decedent had jointly owned the property with another individual, the post-death basis is made up of two parts; the surviving tenant’s part of the original basis plus the value of the portion of the property included in the decedent’s estate. For depreciated property, the combined new basis is also reduced by the depreciation that had been allowed to the surviving tenant; the decedent’s previously claimed depreciation is ignored. For example, Mother and Son invested $60,000 each for a rental property that they owned as joint tenants with the right of survivorship. Up to the date of Mother’s death, depreciation of $20,000 had been claimed. The fair market value at Mother’s date of death was $200,000. The inherited basis of the property is $150,000 ((50% x $120,000) (50% x $200,000) - (50% x $20,000)).

If the beneficiary and the decedent jointly owned the property, and the beneficiary continues to use the property for business or rental purposes after the co-owner’s death, the beneficiary continues depreciating his or her adjusted basis under the same method used in previous years. Depreciation on the part of the basis inherited from the decedent starts anew as of the date of death using the modified accelerated recovery system (MACRS).

A surviving spouse who inherits community property from his or her deceased spouse that was used for business or rental purposes does not reduce the inherited basis by any portion of the depreciation attributable to the period prior to the spouse’s death. The entire new basis (less any land portion if the property is real estate) is depreciable.

 

Below is a link to Reg 1.1250(3)( b ) that also talks of basis, gain calcs, and how the additional depreciation that is normally used in computing depreciation recapture prior to death is adjusted to zero immediately after death. The deprec recapture would only come into play if the property was acquired by the transferee prior to death, and then the gain would be considered IRD and would be subject to recapture.

 

Anyway, the section I referenced starts at the top of the right-hand column on page 2, and continues on with an example on page 3:

 

http://www.gpo.gov/fdsys/pkg/CFR-2012-title26-vol11/pdf/CFR-2012-title26-vol11-sec1-1250-3.pdf

[joanmcq]

Thanks, Judy. It was solely owned by the decedent and solely inherited by my client, his fiancée. Rental properties in two nonresident states, plus the primary residence in CA. So three probates my poor client is wending through.

[RHCPA]

jklcpa - thank you for this information. I wondered where you obtained the blue text with the example. I thought that 1014(b)(9) would force the surviving spouse to reduce her basis by prior depreciation that she benefitted from in the past. Could you possibly explain wht 1014(b)(9) would not apply. It seems wrong that the surviving spouse could step up a fully depreciated rental property and depreciate the whole thing. Not challenging your information  - just trying to get an understanding of the logic here and see if it is really possible to treat a property exactly as stated in your last blue sentence. Thank you in advance!!

[jklcpa]

I can't provide the source of that from four years ago!  Heck, I may not be able to remember what I wore or ate last week.    I tried to answer before and lost the whole post, and not sure what happened there!

As I understand it, in community property states, if the property is community property (not joint property that was brought into the marriage), then the 100% of the value of that property is included in the gross estate for valuation purposes and doesn't matter if a tax filing is necessary. For this to apply, at least 50% of the value must be included in the estate valuation, and if this is the case, then the spouse uses the stepped up basis on the entire property and depreciation starts over.

I believe the references for this are:

• reg sec 1.1014-2(a)(5) and 1.1014-1, and
• IRC 1014(a) and 1014(b)(6)