Pre-1977 Purchases May Get 100% Step-up or Not!

Published on: 17:20PM Jan 31, 2016

~~We had a reader respond to our last post with the following:

"One additional thought on the “Farmer Brown purchased 40 years ago” example.  If it was a pre-1977 joint interest, his wife could get a 100% basis step up, if the funds to purchase the property and pay for the mortgage came solely from Farmer Brown’s income (Gallenstein decision to which IRS acquiesced)."

The Gallenstein case was originally decided in 1991 in favor of the taxpayer and then appealed by the IRS to the Sixth Circuit which also found for the taxpayer.  Mr. and Mrs. Gallenstein had purchased some farmland back in 1955 from the earnings of Mr. Gallenstein (this is important) which was owned jointly by them.  On December 12, 1987, Mr. Gallenstein passed away and on July 5, 1988, Mrs. Gallenstein sold the farmland for $3,663,650. 

The original tax return showed a gain of $3,556,596 since they only deducted the original purchase price of$103,000.  Subsequently, they filed an amended tax return to update the basis to $1,838,685 to reflect half of the fair market value of the land when Mr. Gallenstein passed away.  The IRS issued a refund of $105,395.

One final amended tax return was filed to request a refund of $115,152 which reflected adjusting the cost basis to 100% of the fair market value of the land at the time of Mr. Gallenstein's death.  The IRS did not issue that refund and that is when it went to court.

Under the old law, joint interest owners had to track the amount that each person contributed to the purchase of the property.  In 1976, Congress amended this part of the law to provide for joint interests created after December 31, 1976; tracking was not required and one-half would be included in each estate. 

In 1981 Congress again made sweeping changes to estate tax rules for married couples and eliminated the new 1976 provision with a new provision indicating joint interests would be reported 50/50 on a couple's estate tax return.  However, the new changes did not specifically eliminate the provisions that were in place before 1976 and thus this is what the Court decided.

The Court ruled in favor of the taxpayers by stating since the joint interest was formed before 1977 and the husband contributed all of the funds to purchase the farmland, Mrs. Gallenstein was entitled to a full step-up in basis. 

This was a major victory for Mrs. Gallenstein and if you have purchased property before 1977, this rule may or may not help your spouse if they sell the property after your death.  If you provided all of the funds to purchase the property and pass away, your spouse will get a full step-up.  However, if you did not contribute any of the funds to the purchase of the property and you pass away, then your spouse will need to use their original cost on the sale of property.  However, if it then goes through their estate, those heirs will get a full step-up.

As with many tax questions, the answer is it depends.