Under the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), the estate tax was to have been repealed for individuals dying in 2010, and the rules allowing a step-up in basis for property acquired from a decedent were to have been replaced with a modified carryover-basis regime ( Code Sec. 1022). Under this modified regime, a recipient's basis in property acquired from a decedent was the lesser of (i) the decedent's adjusted basis in property, or (ii) the fair market value (FMV) of the property on the decedent's date of death.

The 2010 Tax Relief Act restored the estate tax for individuals dying in 2010 with a $5 million per-person exemption and a maximum rate of 35%. It also repealed the modified carryover-basis rules for property acquired from a decedent who died in 2010. However, Sec. 301(c) of the 2010 Tax Relief Act allows estates of individuals dying in 2010 to elect zero estate tax and the modified carryover-basis rules that would have applied before they were repealed (a “ Code Sec. 1022 election”). Additionally, Code Sec. 1022(b) and Code Sec. 1022(c) allow an executor to allocate additional basis to certain property.

On August 5, 2011, the IRS released Notice 2011-66. The Notice provides guidance with regard to the time and manner in which the executor of a 2010 decedent elects to have the estate tax not apply, and to have the carryover-basis rules apply. The executor makes the section 1022 election by filing Form 8939. The Notice provides that Form 8939 is due November 15, 2011. But on Sept. 13, the IRS changed the due date to January 17, 2012. See Notice 2011-76. The IRS will not grant any further extension of time to file Form 8939, to make the Section 1022 Election, or to amend or revoke the Section 1022 Election, except as provided in the limited circumstances described in Notice 2011-66. Once made, the election is irrevocable except as provided in the Notices. Prior filings purporting to make the section 1022 election must be replaced with a timely filed Form 8939.

Additionally, the penalties for failure to file an information return or to provide information to beneficiaries do not apply to the executor of a 2010 estate solely because (i) the Form 8939 is filed after Nov. 15, 2011 but on or before Jan. 17, 2012, or (ii) a statement required to be furnished to beneficiaries is provided after Dec. 15, 2011 but on or before Feb. 17, 2012.

The IRS expects to release Form 8939 and the related instructions this fall. Notices 2011-66 and 2011-76 also contain guidance on some issues relating to the generation-skipping transfer (GST) tax.

On August 5, the IRS released Revenue Procedure 2011-41. The Procedure contains optional safe harbor guidance for applying the rules under section 1022. If the executor of the estate of a decedent who died in 2010 makes the section 1022 election and follows the applicable provisions of the revenue procedure and takes no contrary return positions, then the IRS will not challenge the taxpayer’s ability to rely on the provisions, either on the Form 8939 or on any other return of tax.

Under section 1022, property acquired from a decedent is treated as transferred by gift. The transferee’s basis is the lesser of the decedent’s adjusted basis or the property’s fair market value as of the date of the decedent’s death.

The executor can increase the basis of appreciated property owned by the decedent by $1.3 million, plus the sum of the decedent’s capital loss carryover, the decedent’s net operating loss carryover, and the unrealized losses that would have been allowable under section 165 if the property acquired from the decedent had been sold at fair market value immediately before the decedent’s death. The executor can increase the basis of qualified property passing to a surviving spouse by an additional $3 million. The executor cannot increase the basis of any property above its fair market value as of the date of the decedent’s death.

Revenue Procedure 2011-41 resolves several issues that were unclear. Below is a discussion of some, but not all, of the issues discussed in the Revenue Procedure.

It says that, for purposes of computing the decedent’s unrealized losses, the usual dollar limitations on capital losses do not apply. In example 3 in the Procedure, a decedent owned stock with a basis of $5,000 and a fair market value of $1,000. If the decedent had sold the stock immediately before his death, he would have had a net capital loss of $4,000. Based upon his 2010 income, he would have been able to deduct $3,000; the remaining $1,000 would have been carried to future years. For purposes of section 1022, however, the executor may use the entire $4,000 unrealized loss to increase the basis of other assets.

The Procedure also makes clear that the executor may allocate basis increase to property owned by and acquired from the decedent even after the executor has disposed of or distributed the property.

The Procedure also discusses the holding period. It says “To the extent the recipient’s basis in property acquired from the decedent is determined under section 1022, the recipient’s holding period of that property shall include the period during which the decedent held the property, whether or not the executor allocates any Basis Increase to that property.”

Some commentators had previously pointed out that IRC § 1223(2) provides for tacking the holding period only if the transferee’s basis was determined in whole or in part by the transferor’s basis. Under section 1022, if the decedent’s adjusted basis is less than or equal to the property’s fair market value on the decedent’s date of death, then the recipient’s basis is the decedent’s adjusted basis. The basis of such property is determined in whole or in part by the decedent’s basis. Therefore, the recipient’s holding period includes that of the decedent.

But if the decedent’s basis is greater than the property’s fair market value on the date of death, then the recipient’s basis is the fair market value. § 1022(a)(2)(B). The basis of such property is not determined in whole or in part by the decedent’s basis. Therefore, tacking does not apply to such property, these commentators believed. Instead, the date acquired for such property is the decedent’s date of death. In other words, the recipient has a brand new holding period.

The Procedure does not specifically address this debate. However, the above quoted sentence suggests that the IRS believes tacking applies to all property covered by section 1022.

IRS Notice 2011-76, released on September 13, provides penalty relief for taxpayers who inherited property from a 2010 decedent and sold the property in 2010. When the recipient of such property files his 2010 income tax return, he may not know whether the executor will make the section 1022 election and, if so, the amount of basis increase that the executor will allocate to the property. Therefore, the recipient may not know the property’s basis or other pertinent information such as tax character and holding period. When filing the recipient’s income tax return and computing the income tax liability, the recipient will have to make a good faith estimate, based on the facts and circumstances, regarding such information with respect to the property acquired from the 2010 Decedent. Accordingly, to the extent that the recipient’s tax liability is increased, as shown on an amended return or otherwise, by reason of the application of section 1022 to the estate of a 2010 decedent, the recipient’s reasonable cause and good faith for the underpayment will be presumed, and the IRS will not impose either the section 6651(a)(2) addition to tax for failure to pay, or the section 6662(a) penalty for negligence, disregard of rules or regulations, or a substantial underpayment of tax. The recipient should write across the top of the amended return “IR Notice 2011-76” to alert the IRS that the recipient meets these requirements for reasonable cause.