Step-down in basis

Question:

My 100-year-old mother formed an irrevocable trust for Medicaid-planning purposes back in 1997. It has a brokerage account that holds a T bill and some stocks. The stocks have a fairly significant losses that will not be able to be used by my mother. She reports all income from the trust on her 1040 return. When she passes would I be able to take the value of that account as part of my inheritance and sell the stocks in the account and pass those losses through to me?

Response:

That’s an interesting question. It sounds like it’s a grantor trust so the trust property will be in your mother’s taxable estate. In almost all cases, stock and real estate appreciates in value over time and when the owner dies the property gets a “step-up” in basis to the value on the date of death. This usually is to the benefit of the heirs since it eliminates any capital gain they might realize on the sale of inherited property.

But you have the unusual situation where the trust property decreased in value since your mother or her trust purchased it. You would prefer not to have an adjustment in basis down to its current value so that you can take a loss on the the sale. Unfortunately, 26 U.S. Code § 1014 states: “the basis of property in the hands of a person acquiring the property from a decedent or to whom the property passed from a decedent shall, if not sold, exchanged, or otherwise disposed of before the decedent’s death by such person, be—
(1) the fair market value of the property at the date of the decedent’s death.”

In other words, the basis in property, whether real estate or shares of stock, is always adjusted to the date of death value upon the death of the original owner. There’s no exception for property that has decreased in value. So, if your mother bought a share of stock for $100 and it’s worth $50 when she dies, $50 will be the new basis. If you inherit the stock and then sell it for $75, you will have a capital gain of $25, rather than a loss of the same amount.

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