Carry-over Basis Example

Although potential heirs may think they’d be better off if their rich grandfather died at the end of 2010 rather than the beginning of 2011, that may not be the case due to the carry-over basis. George Steinbrenner’s estate will probably pass to heirs tax-free this year, but his heirs may end up owing millions in capital gains taxes when they sell the assets. Nobody is concerned about the Steinbrenner heirs, but it’s the taxpayers who inherit small businesses that will be hit the hardest by the carry-over basis of 2010. Here’s an example of how the carry-over basis affects small business owners:

“Say Uncle Harry built his business with sweat equity. His company was worth $3 million when he died, but its tax basis was zero. Jack inherits the firm and sells it right away. If Harry died in 2009, there would be no tax (since Harry’s estate was worth less than $3.5 million it owed no estate tax, and thanks to stepped-up basis Jack owed no capital gains tax). But under 2010 rules, Jack would owe $255,000 ($3 million less the $1.3 million in allowed step-up leaves $1.7 million in gains taxed at 15 percent).”

Howard Gleckman, No Estate Tax, But 2010 Still May Not be so Great for Heirs, Tax Policy Center, Sept. 30, 2010.

Special thanks to Jim Hillhouse (WealthCounsel) for bringing this to my attention.