Depreciable Basis - Stepped Up

[Corduroy Frog]

Millard and Maude - married elderly couple.  Millard owns a commercial warehouse by himself, but Maude owns no part of it.

Millard's original cost is $400,000 years ago, with $350,000 in accumulated depreciation.  Millard passes away in 2022, leaving the warehouse to Maude.

Maude has warehouse appraised, FMV is now $1,000,000.  What is Maude's new depreciable basis?  (for this purpose, ignore the effect of non-depreciable land):

a.  $1,000,000 the new FMV of the warehouse.

b.  $  650,000 because Millard already took $350,000.

c.  $  350,000 calculated at Millard's (400,000 + 1,000,000) divided by 2, less Millards $350,000 already taken.

d.  ?????

Have researched The Tax Book, and find numerous references to stepped up value, but nothing regarding new depreciation.

To all who might be interested, thank you in advance -

[Lee B]

Quick online search found a long list of detailed articles about this. Correct answer is "a"

[DANRVAN]

There is not enough information given.  The answer is either (a) or $525,000.

There is no logic behind answers b or c.

Just because the property was solely titled by deceased spouse does not mean it goes 100% to his estate.  For example if he acquired the property with money he earned during the married,  it could be considered marital property and 1/2 would go to his estate.  If on the other hand he acquired the property before the marriage. it would most likely be considered separate property and go 100% to his estate.

There are several factors in determining if the property is marital or separate for estate purpose and determining basis.

If considered marital property then surviving spouse gets 1/2 stepped up basis, so in this case her net basis is $525,000.

Answer (a) would be correct if they reside in a community property state.

2 hours ago, Corduroy Frog said:

numerous references to stepped up value, but nothing regarding new depreciation.

Apparently you do not understand the concept of stepped up basis; it is a clean slate and prior depreciation is disregarded.

[Corduroy Frog]

Thank you to Lee B and DANRVAN for clarification.

[Sara EA]

Agree that (a) is correct.  I've had cases where a rental property was jointly owned.  When one spouse died, that half gets stepped-up value and starts depreciation anew.  The surviving spouse gets half the original basis and accumulated depreciation (because the other half belonged to the deceased).  You have to get rid of the old asset and start two new ones.  Using the numbers in the OP, the wife would have a basis of $500k + $200k - $175k.

[JohnH]

I was interested in the answers to this question because I had a similar situation about 8 years ago.  It was nice to get confirmation that my handling of the step up in basis was correct.  

Lately I've been playing around with ChatGPT. Out of curiosity, I decided today to submit a slight variation of the original question to ChatGPT just to see what it would respond.  (I simply said that the property was fully depreciated when the spouse died in order to simplify the question a bit). In case anyone is interested, here is the reply from ChatGPT.

---> When a person inherits a rental property, the tax treatment of the property's depreciation depends on several factors, including the tax basis of the property and whether it was held in a single-owner or joint ownership situation. Here are some key points to consider:

Step-up in Basis: When someone inherits a property, the tax basis of the property is typically "stepped up" to its fair market value as of the date of the decedent's death. This means the beneficiary's new tax basis for the property is the fair market value on the date of death, not the original cost of the property.

Single Ownership: If the spouse owned the rental property in their name alone and the property's basis is stepped up to its fair market value upon their death, the surviving spouse can start depreciating the property again based on the new stepped-up basis. The depreciation is calculated over the useful life of the property, which is determined by the IRS based on the property type (residential, commercial, etc.).

Joint Ownership: If the rental property was owned jointly with the spouse, the basis adjustment upon the death of one spouse depends on the ownership structure. In a joint tenancy with the right of survivorship or tenancy by the entirety, the surviving spouse typically receives a full step-up in basis for their share of the property. The surviving spouse can start depreciating their share of the property based on the new stepped-up basis. <---

It ended with a boilerplate statement to consult your tax pro, etc.  
All in all, I'm awarding ChatGPT an A+ on this one. 

[Lion EA]

So, what document do we need to see if the property on a joint return was held in a joint tenancy with the right of survivorship or tenancy by the entirety? What other ownership structures are available? What would be the outcome for those other structures? What ownership structures would result in 1/2 step-up basis and 1/2 original basis/depreciation? Will the new basis for depreciation always be the same as the new basis for sale?

[Lee B]

1 hour ago, Lion EA said:

So, what document do we need to see if the property on a joint return was held in a joint tenancy with the right of survivorship or tenancy by the entirety? .   .   .   .   What will the new basis for depreciation always be the same as the new basis for sale?

How many clients could answer question # 1 ?     I would think that the depreciable basis and the sales basis would be the same?

For me this discussion reinforces my decision to stay within my area of expertise and to stay away from Estate and Trust work

[Lion EA]

I'm glad I have no clients with rentals. However, as I age, my clients age, and I'm thinking about those personal residences, how to find out how they're titled, what will be the adjusted cost basis if a surviving spouse sells. Or, if one of my clients is a kid/heir to parent's personal residence, and sells it. Or rents it out for a couple years before selling!

Had a long-time client who inherited shares of her mother's investments that included 3 rental real estate partnerships, as well as other complex investments. I told her I would no longer prepare her returns. (Divesting myself of CA clients, so that gave me a reason to tell her to find someone local to her sooner rather than later.) Client had moved from CT where I am to CA to care for her mom; went from a W-2 to a 1099-R to inheriting 1/3 of apartment building partnerships and other complex investments with no depreciation tables and no CA K-1s and her HRB-employee sister and her TurboTax sister telling her how to report things. She would never accept my price increase to account for my time and research and listening to her arguments from her siblings. She wanted me to prepare her taxes one more year before she found a local tax preparer. I refused to spend my time setting up her new situations now for her new preparer next year, and told her that THIS is the year for her to begin with a new preparer. Hated to lose her, but knew she wouldn't be happy with the fee I needed to charge for my time -- especially since she's comparing my fee to her siblings' TT price and HRB-employee probably free returns.

[Corduroy Frog]

7 hours ago, Lion EA said:

So, what document do we need to see if the property on a joint return was held in a joint tenancy with the right of survivorship or tenancy by the entirety?

How about asking the client?  (assuming they really know). 

There is a bigger issue involved here...how well can we depend on what the client tells us?  I believe we should rely on their information, with a few exceptions, such as things that are obviously "wrong with this picture."

Examples:  Self-employed taxpayer with $15,000 in self-employment income, living in a $3,000,000 home.  Taxpayers who can't tell Lion's difference between joint tenancy or tenancy by the entirety without consulting their attorney.  US Citizens over 70 years of age who don't have 1099-SSA information returns...

And the 8867 where the preparer asks questions that the IRS insists is not auditing, even if we are supposed to keep documentation?  (TurboTax self-prepared returns will not have an 8867)

A bigger issue indeed, maybe outside the scope of this thread stepped-up basis.

[Sara EA]

AI is wrong on the joint ownership part.  This from Pub 551.  Just above this quote there is an example for surviving tenants that shows the same math I used above.  You can all stop worrying about whether assets were held as tenants in common or w/ right of survivorship.  I give AI a C.

Qualified Joint Interest

Include one-half of the value of a qualified joint interest in the decedent's gross estate. It doesn't matter how much each spouse contributed to the purchase price. Also, it doesn't matter which spouse dies first.

A qualified joint interest is any interest in property held by married individuals as either of the following.

Tenants by the entirety.

Joint tenants with right of survivorship if the married couple are the only joint tenants.

Basis.

As the surviving spouse, your basis in property you owned with your spouse as a qualified joint interest is the cost of your half of the property with certain adjustments. Decrease the cost by any deductions allowed to you for depreciation and depletion. Increase the reduced cost by your basis in the half you inherited.