How spousal ownership affects inherited tax basis

The starting rule for an inherited interest

Property acquired from a decedent generally takes a basis equal to its fair market value at death, or its applicable alternate valuation value if that election is made.

This rule has exceptions. Income in respect of a decedent, meaning income earned but not received before death and not properly includible on the final return, receives no new basis.

If appreciated property was given to the decedent within one year before death and passes back to the donor or the donor's spouse, its basis remains the decedent's adjusted basis immediately before death.

For this exception, appreciated means fair market value exceeded adjusted basis when the gift was made. The exception also applies to sale proceeds the donor is entitled to receive.

Community property can qualify both spouses' interests

The surviving spouse's half of community property is treated as acquired from the decedent if at least half of the whole community interest was includible in the deceased spouse's gross estate.

The property must be community property under the applicable state, territory, possession or foreign law. When those conditions are met, both spouses' interests fall under the inherited basis rule, subject to its exceptions.

Before applying that treatment, review separately received gifts and inheritances, purchases with separate funds and purchases with mixed community and separate funds. These generally create separate property interests under the applicable domicile law.

Property converted from community to separate property through an agreement valid under applicable state law is generally separate property. The surviving spouse's community property basis treatment requires community property.

Qualified joint interests combine two basis amounts

A qualified spousal joint interest is property held by married individuals as tenants by the entirety, or as joint tenants with right of survivorship when the spouses are the only joint tenants.

Generally, half its value is included in the deceased spouse's gross estate, regardless of purchase contributions or which spouse dies first. The noncitizen surviving spouse exception appears below.

The survivor's basis equals the cost of the survivor's half, reduced by depreciation and depletion deductions allowed to the survivor, plus the basis of the inherited half.

The inherited half follows the inherited basis rule and its exceptions described above. Keep the survivor's purchase and depreciation records alongside the inherited valuation records.

Separate ownership and tenancy in common require the actual interest

For separately owned property or a tenancy in common, estate inclusion follows the deceased spouse's actual ownership interest at death. Apply the inherited basis rule to the interest acquired from that spouse.

Do not substitute the qualified joint interest half rule for the actual ownership interest. Ask your advisers to reconcile the ownership documents with the purchase and transfer records.

A noncitizen surviving spouse requires a separate review

The qualified spousal joint interest half inclusion rule generally does not apply when the surviving spouse is not a United States citizen.

An exception covers property passing in a qualified domestic trust, including property transferred to that trust before the estate tax return is made.

It also covers property irrevocably assigned to that trust by that date through an assignment enforceable under local law.

Another exception requires the survivor to become a United States citizen before the return is made and remain a United States resident continuously between the death and citizenship.

Qualified domestic trust eligibility, elections and administration belong in a cross border planning review. Bring both spouses' citizenship and residence information to that discussion.

Lifetime spousal transfers follow a different basis rule

A lifetime transfer by an individual to a spouse, directly or in trust for that spouse's benefit, generally recognizes no gain or loss. The recipient generally takes the transferor's adjusted basis.

The nonrecognition rule does not apply to a transfer to a nonresident alien spouse.

For a transfer in trust, nonrecognition does not apply to the extent assumed liabilities plus liabilities on the property exceed its total adjusted basis. The recipient's basis must be adjusted for the resulting recognized gain.

Review any contemplated transfer with the gift back exception described above.

Two related terms

Community property. Community property is property classified as community under the law of the state or foreign country where you are domiciled.

Grantor trust. When the grantor is treated as owner of a trust portion under federal grantor trust rules, that portion's income, deductions and credits go on the grantor's return.

Investor Advantage perspective

One participant described the experience of connecting different planning systems. That perspective is useful when preparing an ownership review involving more than one jurisdiction.

"our focus is always started from the defense perspective. taxes, asset protection, estate planning. That always drove everything. But really, over time, what's what what's happened for us is that we've become the converter between various systems."

Common questions