For executors choosing the default $5 million estate tax exemption regime, it was, for the most part, business as usual. However, for executors who ultimately opted out of the estate tax altogether, the year presented one challenge after another.

One of the more significant hurdles faced in 2011 was awaiting the Internal Revenue Service’s release of Form 8939 to allocate basis pursuant to Internal Revenue Code Section 1022 (the modified carryover basis rules). Although a draft form was available early in the year, many feared that the final form would contain drastic changes sending practitioners back to the drawing board. Just weeks before the Nov. 15th deadline to file the form, the IRS extended the due date to Jan. 17, 2012 and weeks later, finally released the final form and corresponding instructions.

Determining Cost Basis

Form 8939 is relatively simple to complete and didn’t present any significant surprises. However, the struggle to determine cost basis was prevalent across the asset spectrum. For almost all executors, a major concern was determining the value of capital improvements made when the decedent owned the property. Determining the original purchase price was relatively simple, as that information is generally well documented. Particularly for primary residences purchased decades ago and in cases in which the decedents didn’t intend to sell the property, increasing the cost basis by the cost of capital improvements proved far more difficult. In most cases, decedents were expecting a full step-up in basis at death and, therefore, didn’t keep adequate records and receipts of costs. Many of our clients faced the difficult task of trying to reconstruct history to establish a good-faith estimate of basis.

Another issue that arose was determining the cost basis and date of acquisition of particular securities in large investment accounts. Rarely is it necessary to analyze securities in this degree of detail. Working with investment companies to obtain date of death values for securities held within a decedent’s account is fairly routine. However, breaking out the cost basis and date of acquisition for each security is a far more complex task, especially since most investment advisors aren’t accustomed to receiving requests for this information. In some cases, when clients owned interests in limited partnerships, cost basis was dependent on information in each partnership’s K-1s. Obtaining timely, finalized K-1s from partnerships often resulted in unforeseen delays and additional expense.

Perhaps the most significant development that emerged during 2011 was the state interpretation of the 2010 estate tax legislation. For instance, in Massachusetts, where state and federal income tax laws intersect, the determination of basis on property inherited in 2010 to assess future capital gains tax posed a serious issue. Without much warning, late in the fall of 2011, the Massachusetts Department of Revenue released a directive indicating that its reading of the legislation subjected all 2010 estates to IRC Section 1022’s modified carryover basis rules. The net result has been that estates applying the default $5 million federal estate tax exemption weren’t required to file any federal return or forms and received no step-up in basis. Down the road, this could result in a capital gains tax for those who inherited Massachusetts property in 2010. Practitioners in that state have no clear answer as to how to address this issue and are now forced to carefully examine the same issue in every other state in which decedents owned property.

We’ve been administering the estates of decedents who passed away in early 2010 for over two years. These estates have certainly presented numerous unique challenges, as most estate planning professionals and financial advisors can appreciate. However, it’s the executors and beneficiaries of these estates who have truly felt the burden of the delays and challenges these legislative changes have presented. They deserve the credit for grappling with issues that have proven daunting even for seasoned tax professionals.