Carryover Basis - Explained
What is Carryover Basis?
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Table of ContentsWhat is Carryover Basis?How Does Carryover Basis Work? Carryover Basis vs. Step-up BasisEliminating the Step-Up BasisAbout the Gift TaxModified Carryover Basis RegimeKey TakeawaysAcademic Research on Carryover Basis
What is Carryover Basis?
A carryover basis is a method used to determine an assets tax basis when transferring it to another person. The use of a carryover happens when an individual gifts another person the asset. In this case, the basis will generally be the same as the person giving or transferring it.
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How Does Carryover Basis Work?
A carryover basis applies when there is an asset set for sale, and you want to determine the payable tax rate of this particular asset. Generally, a carryover basis has a major consideration mostly in estate planning, especially when an individual is considering restructuring a transfer of assets to the heir.
Carryover Basis vs. Step-up Basis
The carryover basis is different from the step-up basis. The carryover basis is applicable during a givers lifetime. On the other hand, a step-up basis is used to transfer inheritance after the giver dies. Also, in a step-up basis, the assets value under transfer is usually adjusted to match the current market value. Generally, the carryover basis effect on gifts is taxing of the accrued gain that has not been realized by the giver, when the receiver of the gif sells the asset. When it comes to effecting step-up basis effect on inheritance, it eliminates income tax on any gain accrued that is unrealized by the heir.
Eliminating the Step-Up Basis
The following events have been in existence as a move to eliminate or repeal the step-up basis: The 1976 Tax Reform Act was to impose a tax on a carryover basis on every asset that a person inherits. However, this move was repealed before it became effective. In 2001, the Economic Growth and Tax Relief Reconciliation Act repealed the estate tax and in the process, curtailing the set-up basis, but for one year alone. The act was able to limit set-up basis to %1.3 million. There was also an additional $3 million for surviving spouses, including any other unrealized carry over gains. To retain the set-up basis, estate owners were supposed to pay estate tax.
About the Gift Tax
Gift taxes forms an integral part of the carryover basis. A gift tax is a federal tax that applies to events where the receiving person is not obligated to pay the giver full gift value. The fact that the receiver may sometime pay a few dollars for the gift, the tax burden always lies with the giver. On the other hand, levying of the estate tax is usually on the person inheriting the estate. The estate values exclusion limit combined both the gross assets and prior taxable gifts that surpassed $11.18 million in 2018. If this is broken down, then an estate that is worth $11 million does not qualify to file a tax return, meaning that it is exempted from paying estate-related tax. Though there is levying of the estate tax on assets passed to the heir, it is not applicable to assets a surviving spouse inherits. Note that when a spouse leaves any amount of money to another, it is called unlimited marital deduction, and it usually excluded from a gift tax. Other gift tax exclusion includes:
- Gifts to political organizations
- Medical and educational expenses. For instance, a grandparent can pay tuition fees for his grandchild, and he is not penalized by the gift tax.
- Gifts whose value is less than the annual tax exclusion
Modified Carryover Basis Regime
In 2010, the heirs of the donor had the option of taking the full step-up basis or make use of the modified carryover basis regime. What is meant when heirs choose a modified carryover basis is that their fair market value will be lesser of the donors property on either of the following:
- The date of death but not the entire step-up basis
- The original income tax basis of the decedents in the property
- Certain values improvements (Note that this does not include the full step-up basis)
Lets assume that the decedent pays $3 million to acquire a portion of a real estate. However, he or she does not make any improvements to it. At the date of his death in 2010, there happens to be an increment in the fair market value to $5 million. In this case, the heir will inherit the real estate with a $3 million carryover basis income tax. But if there is instead a decrease in the fair market value to $2 million at the date of the decedents death, then the heirs carryover basis in the estate will be $2 million.
- A carryover basis is a method used to determine the tax basis that has an association with an asset when transferring its ownership to another person
- A carryover basis has a major consideration mostly in estate planning, especially when an individual is considering restructuring a transfer of assets to the heir.
- When heirs choose a modified carryover basis is that their fair market value will be lesser of the donors property
- When a spouse leaves any amount of money to another, it is called unlimited marital deduction, and it usually excluded from a gift tax
Academic Research on Carryover Basis
- A Deemed Realization Approach Is Superior to Carryover Basis (and Avoids Most of the Problems of the Estate and Gift Tax), Dodge, J. M. (2000). A Deemed Realization Approach Is Superior to Carryover Basis (and Avoids Most of the Problems of the Estate and Gift Tax). Tax L. Rev., 54, 421.
- Carryover Basis: The Case for Repeal, Blum, M. E. (1978). Carryover Basis: The Case for Repeal. Tex. L. Rev., 57, 204.
- Carryover Basis Repeal and Reform of the Transfer Tax System, Osgood, R. K. (1980). Carryover Basis Repeal and Reform of the Transfer Tax System. Cornell L. Rev., 66, 297.
- Carryover Basis Rules for Inherited Property, Hightower, R. S. (1977). Carryover Basis Rules for Inherited Property. Fla. St. UL Rev., 5, 153.
- LBO Accounting: Unveiling the Mystery of Carryover Basis, Gorman, J. (1988). LBO Accounting: Unveiling the Mystery of Carryover Basis. Journal of Accountancy, 166(4), 71.
- Post-Mortem Tax Planning for Carryover Basis Property, Asofsky, P. H. (1977). Post-Mortem Tax Planning for Carryover Basis Property. Tax Law., 31, 701.
- Taxation of Unrealized Gains at Death-An Evaluation of the Current Proposals, Graetz, M. J. (1973). Taxation of Unrealized Gains at Death-An Evaluation of the Current Proposals. Va. L. Rev., 59, 830.
- The Internal Revenue Code of 1954: Carry-Overs and the Accumulated Earnings Tax, Cohen, E. S., Phillips, P. A., Surrey, S. S., & Tarleau, T. N. (1954). The Internal Revenue Code of 1954: Carry-Overs and the Accumulated Earnings Tax. Tax L. Rev., 10, 277.
- Taxing Gains at Death: A Further Comment, Galvin, C. O. (1993). Taxing Gains at Death: A Further Comment. Vand. L. Rev., 46, 1525.
- The Case for a Stepped-Up Basis to the Transferee in Certain Reorganizations, Levin, J. S. (1961). The Case for a Stepped-Up Basis to the Transferee in Certain Reorganizations. Tax L. Rev., 17, 511.Realization of Gains Under the Comprehensive Inheritance Tax, Cunningham, L. E., & Cunningham, N. B. (2009). Realization of Gains Under the Comprehensive Inheritance Tax. Tax L. Rev., 63, 271.