Question: My father died in 2005. At the time, my Mom and Dad’s assets were put into two trusts: a survivor’s trust for my Mom and a bypass trust that pays Mom income for the rest of my life. There are some stocks and some real estate in both trusts that have increased greatly in value, and it has recently come to my attention that when I inherit the assets in those trusts the cost bases of the appreciated assets in the survivor’s trust, but not the bypass trust, get stepped up. Is this true? Is there any way to change that while my Mom is alive?
Answer: Congress has made significant changes in estate tax law since your dad passed away in 2005. You and your mom should meet with a knowledgeable estate planning attorney and discuss the options presented in this column.
The purpose of the bypass trust was to use your dad’s estate tax exemption to keep those assets out of your mom’s estate. That way, your dad’s assets in the bypass trust would “bypass” any estate tax when your mom dies.
Times have changed. In 2005 the dollar amount of assets excluded from estate tax was $1.5 million and assets above that were taxed at 46 percent. Today $5.45 million is excluded and the tax rate is 40 percent. Michael Jones, a CPA in Monterey who specializes in advanced estate planning, says that under current law an estate tax return can be filed for the deceased spouse on which “portability” can be elected, allowing the surviving spouse to carry forward the deceased spouse’s estate tax exemption. Today, that combination equals $10.9 million minus the value of the first taxable estate.
When the first spouse dies and a trust that receives the decedent’s property grants the surviving spouse the right to all income for life, the trustee may elect to place some or all of the deceased spouse’s assets in a Qualified Terminal Interest Property (QTIP) trust. The QTIP trust postpones the estate tax on assets in that trust until the surviving spouse dies. After the surviving spouse dies, the value of each asset in the trust is “stepped up” to its value on the decedent’s date of death, just like it is for assets in the survivor’s trust. This allows the beneficiary to sell those assets and only pay tax on whatever appreciation occurred after the date of death of the surviving spouse. This also means the cost basis used to calculate depreciation on investment real estate is stepped up.
According to Yvonne Ascher, a Monterey attorney and certified specialist in estate planning, there is a new IRS Revenue Procedure this year that may allow your mom to recharacterize the bypass trust as a QTIP trust and cause the trust assets to receive a new basis following your mom’s death. Such an election is possible if the terms of the bypass trust satisfy the requirement for the QTIP election — namely, the surviving spouse must be entitled to all the income, and he/she must be the only current beneficiary. However, such an option is only available if no Federal Estate Tax Return (Form 706) was filed on the first death. The late return electing QTIP treatment can also elect to transfer the deceased spouse’s unused exclusion amount to the surviving spouse. Ask your attorney if the bypass trust might now be eligible for QTIP treatment. Even if not eligible, there are other options that may exist to obtain a new basis, such as petitioning the court to terminate the bypass trust.
Kenneth B. Petersen is an investment adviser and principal of Monterey Private Wealth Inc. in Monterey. Send questions concerning investing, taxes, retirement or estate planning to 2340 Garden Road, Suite 202, Monterey 93940 or firstname.lastname@example.org.