Monday, March 14, 2011

Accrued passive losses may make it worthwhile to elect out of estate tax for 2010 The 2010 Tax Relief Act's estate tax changes interact with other tax rules in many ways, creating pitfalls as well as opportunities. A case in point for practitioners to consider is how “electing out” of the estate tax regime for 2010 may permit utilization of a decedent's accrued passive losses. The following excerpt from Howard Zaritsky's new book, Practical Estate Planning in 2011 and 2012, explains this strategy. Practical Estate Planning in 2011 and 2012, written in response to the recent enactment of the 2010 Tax Relief Act, provides in-depth practical advice on what can and should be done for estate plans in 2011 and 2012, as well as guidance on electing out of the estate tax regime for 2010 decedents. Background. The 2010 Tax Relief Act allows estates of decedents dying in 2010 to choose between (1) estate tax (based on a $5 million exemption and 35% top rate) and a step-up in basis, or (2) no estate tax and modified carryover basis. (Act Sec. 301(c)) In technical terms, the Act achieves this choice by making the estate tax and basis changes effective retroactively for estates of decedents dying after 2009, but allowing the opt-out choice for estates of decedents dying in 2010. Maximizing use of accrued passive losses. Code Sec. 469 limits the ability of a taxpayer to deduct from gross income losses incurred in the conduct of a trade or business in which the taxpayer does not “materially participate.” Nondeductible losses may be carried over for use in the future as an offset against passive gains. Code Sec. 469(g)(2) states that a taxpayer can deduct suspended passive losses on his or her final income tax return to the extent that they exceed the basis of the property in the hands of the transferee. The traditional Code Sec. 1014 estate tax value basis rules significantly limit the amount of suspended passive losses that a decedent can deduct on his or her final income tax return by increasing the basis of built-in gain assets to their estate tax value. By electing out of the estate tax regime, the estate tax value rule is avoided, and Code Sec. 1022 's modified carryover basis rules, by not stepping up the basis of the decedent's built-in gain assets, may result in an increase in the amount of passive losses that may be deducted on the decedent's final income tax return. Illustration : Hilda owns an interest in Acme Business Partnership, in which she does not materially participate. Hilda's share of Acme's losses is $100,000 for tax years 2005–2009, which Hilda had not been able to use. Hilda's basis in her Acme partnership interest is $10,000. The fair market value of Hilda's Acme partnership interest at her death is $100,000. If Hilda's executor allows the estate tax regime to apply to Hilda's estate, Hilda will not be able to deduct the suspended passive losses, because the losses will not exceed the estate's basis in the partnership interests. On the other hand, if Hilda's executor elects out of the estate tax regime and does not allocate basis increases to the Acme partnership interests, the estate can deduct $90,000 of the losses because that is the amount by which the losses exceed the basis in the partnership interests. Hilda's executor must consider all relevant factors in deciding whether to make the election out of the estate tax regime. If Hilda's estate is under her applicable exclusion amount and if the aggregate basis increase and spousal property basis increase will eliminate all or most of the gain on the appreciation in Hilda's assets, however, the ability to make use of the suspended passive losses may make the election out of the estate tax regime appealing. (See Berall, Harrison, Blattmachr & Detzel, “Planning for Carryover Basis That Can Be/Should Be/Must Be Done Now,” 29 Est. Plan. 99, 101 (Mar. 2002))

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