SOME POINTS TO CONSIDER IF DEATH IS A DISPOSITION

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  1. Be careful to bifurcate transfers at death generally where liabilities do not exceed tax basis from the portion subject to liabilities in excess of tax basis. For example, if the property has a gross FMV of 100, liabilities of 50 and a tax basis of zero, how should the new regime apply? It seems that the excess of 50 over 0 or 50 should be liability gain and 100 less 50 or 50 should be regular gain at death. But if the property has a gross FMV of 40, liabilities of 50 and tax basis of 0, there should be 50 of liability gain (50 less 0) and 10 of loss (50-40) or will the regime work that way? What if the tax basis was 50 and liabilities were 50 and gross FMV was 100, is the result that there is no liability gain and 50 of regular gain at death (100 less 50)? If tax basis is 50, liabilities are 40 and gross FMV is 100, is there regular gain at death of (100 less 50) 50 and a tax liability loss of 10 (50 less 40)? If both the regular gain at death rule and liability gain are subject to the same set of rules, do you need to bifurcate between the two, meaning is the measure net equity and not gross equity (with some deduction for debt)? If net value controls, what about deathbed borrowing to reduce the gain?
  2. Note whether the IRD rules of section 691 and the installment sales dispositions at death of section 453B need to be or should be retained. It would seem that there would generally be no need for the IRD rules if stepped up basis at death is no longer free and the exception that excludes installment obligation dispositions at death should be repealed. It would also seem that the rules relating to recapture at death where death does not cause recapture, such as under section 1245, should be repealed.
  3. How are contingent liabilities to be treated under a death is a disposition regime? The current state of the law is generally thought of as treating the FMV of the contingent obligation as included in amount realized and then providing either a deduction or capital expense for the contingent obligation. This issue arose frequently under current law for either taxable sales or nonrecognition transactions. It would seem that the proper approach would be to include the gross FMV at death as an amount realized and to then treat the decedent (or the estate) as paying to the third party the contingent obligation. There would need to be an adjustment mechanism if the actual amount of the liability is more or less than the estimated amount when the obligation is settled.
  4. There needs to be a pre-death anti-abuse rule which addresses deathbed transactions to reduce the gain at death, such as borrowing money on your deathbed as noted earlier.
  5. If a taxpayer dies holding a partnership interest, is the asset subject to tax the partnership interest or the underlying assets? Presumably the former. Should a section 754 election be deemed made unless the estate elects out?
  6. Assets held in disregarded entities, such as grantor trusts, DREs under check-the-box, QSSTs, etc., should be treated as owned directly and, as a general rule, the approach of Rev. Rul. 85-13 should be adopted so that transactions with a disregarded entity are treated as if you sold the asset to yourself.

[1] See, generally, Harry L. Gutman, Taxing Gains at Death, 170 Tax Notes Federal 269, Jan. 11, 2021, providing a broad discussion of pertinent issues.

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