Estate Planning

The Consideration Furnished-Rule

When a decedent owned real estate or stocks with a non-spouse, then the entire value of the asset will be included in the estate of the decedent for federal estate tax purposes unless the surviving joint tenant can “prove” that he or she provided “consideration” for his/her share (meaning that unless the survivor proves to the IRS that he or she spent some of his money or other assets in acquiring his/her interest in the real estate or stocks, then the full value of such assets will be considered 100% owned by the deceased person and 100% of the value of such asset will be counted as part of the decedent’s estate for federal estate tax purposes).  However, when jointly-owned property was received by the joint owners as a gift, bequest or inheritance, then only the decedent’s fractional share of the asset is included in his/her estate for estate tax purposes.  The surviving joint owner will get a stepped-up basis for capital gains tax purposes. 

          Example 1:  Dad and son purchased a vacant lot for $40,000 cash, with each of them contributing $20,000 for the purchase.  They owned the property as joint tenants.  A few years later dad dies and the property has a fair market value of $60,000 at the time of dad’s death.  In this case, only 1/2 of the value of the property ($30,000 / one-half of the $60,000) is included in dad’s estate (because son used son’s money in helping to purchase the property).  As such, son’s basis in the property is now $50,000 (son’s original $20,000 for his one-half interest, and $30,000 / the value of dad’s one-half interest at the time of dad’s death).  {If father had solely paid for the property, then 100% of the property would have been included in dad’s estate, and the son’s basis in he property would be $60,000 – the fair market value of all of the property as valued on the day that dad died.}

 Example 2:  Mom and daughter purchased a condo for $90,000 cash.  Mom paid $60,000 and daughter paid $30,000.  They owned the property as joint tenants.  A number of years later daughter dies and the property has a fair market value of $120,000 at the time of daughter’s death.  In this case, 1/3 of the value of the property ($40,000 / one-third of $120,000) is included in daughter’s estate.  As such, mom’s basis in the property is now $100,000 (mom’s original $60,000 interest plus the $40,000 interest she received from daughter). 

Example 3:  Dad bought a rental home for $120,000 paying $80,000 down and had a mortgage for $40,000.  A couple years later Dad paid off the mortgage with his money, and then he added daughter to own the property with him in joint tenancy.  Several years later the property was worth $150,000 when Dad died.  Since daughter didn’t furnish any consideration (she didn’t pay any of the purchase price or make any mortgage payments), all of the property was included in Dad’s estate for federal estate tax purposes.  As such, daughter’s basis in the property is now the fair market value at Dad’s death:  $150,000. 

Example 4:  Wife inherited a piece of property from her father.  The property was worth $150,000 when the father died.  Wife added her husband as a joint owner.  The couple rents the property out.  Three years later the family learns that husband has cancer.  Husband and wife sign a deed (and it is recorded) which transfers their interest in the property into a trust for her husband (the husband is the trustor and the sole beneficiary during his lifetime).  Husband dies 14 months after the property is transferred into his trust.  His trust states that the property goes to his wife.  The value of the property at the time of husband’s death is $200,000.  Wife’s basis in the property is the fair market value at the time of husband’s death ($200,000) – but had husband died less than 1 year from when the property was transferred to his trust, then the wife’s basis would only be $175,000 (her half valued at $75,000 and her husband’s interest gets a stepped-up basis of $100,000).  When a spouse transfers real estate (stocks or mutual funds also) to his/her spouse, and then the receiving spouse dies and such asset goes back to the surviving spouse, in order for there to be a full stepped-up basis for the surviving spouse, at least 1 year must have gone by from when the surviving spouse transferred his/her interest to his/her spouse and the time when such spouse dies. 

Example 5:  Husband and wife purchased a vacant lot in 1995 for $30,000 cash.  All of the money came from husband’s individual savings account.  When husband died in 2001 the property was worth $42,000.  Even though husband paid 100% for the property from his money, only one-half of the value of the property is included in his estate for federal estate tax purposes.  And thus the wife’s basis in the property is $36,000 (the $15,000 half interest she owned and the $21,000 half interest she received from her husband at his death).  In the case of spouses, there will be a stepped-up basis for only one-half of the property when the spouses owned the property jointly (unless the property was owned before 1977 by one of the spouses who paid all of the consideration for the property – the Gallenstein case rule). 

Example 6:  Husband purchased property before 1977 with his money and the deed showed husband and wife as the owners jointly.  Husband died in the year 2002.  Section 2040(b) of the Internal Revenue Code was amended in 1976 and later in 1981 so that one-half of an asset jointly owned by a married couple is included in the estate of the first spouse to die (and thus there is a stepped-up basis for such one-half interest).  However, under Gallenstein v. United States (91-2 USTC, 1992) and similar cases, if the surviving spouse can claim and prove that all of the consideration furnished (“money paid”) for the purchase of the property was from the deceased spouse, then value of all of the property will be included in the estate of the deceased spouse and there will be a full stepped-up basis.  Similar cases are Patten v. United States, 116 F2d 1029, 1977; Hahn v. Commissioner, 110 T.C. 140, 1988.  The IRS accepted the Gallenstein line of cases by issuing AOD 2001-06, 2001-42 I.R.B. 

 Case:  See Estate of Marie L. Concordia, et al. v. Commissioner (T.C. Memo, 2002-216).  The Tax Court ruled that a niece’s half-interest in her deceased aunt’s real estate wasn’t included in the gross estate of the aunt because the aunt’s estate proved that the niece provided adequate “consideration” for her one-half interest in the property.  The niece’s “consideration” was an agreement with the aunt to allow the aunt to reside in the niece’s home with the niece and her husband.