December 11, 2006
Second Circuit Rules Taxpayers Must Use Estate Tax Value as Basis
In general, Sec. 1015 provides that the adjusted basis of property that is included in a decedent’s gross estate for estate tax purposes is the fair market value (“FMV”) of such property at the decedent’s date of death. Thus, regardless of the adjusted basis a decedent may have had in property prior to his or her death, Sec. 1015 allows the heir of such property to use its FMV at the decedent’s date of death to measure the gain or loss the heir must recognize on the subsequent sale of such property. In Janis v. Commissioner, Docket No. 04-4443-ag (2d Cir., Nov. 15, 2006), the Second Circuit considers what is “FMV” for purposes of Sec. 1015.
In Janis, the taxpayer inherited an undivided one-half interest in an art collection included in his father’s estate for estate tax purposes. The art collection consisted of 464 items of work by various artists. In preparing the father’s estate tax return, the executor of the father’s estate had each piece of art appraised separately and then as a collection. The FMV of the collection included a “blockage discount” of approximately 62 percent of the cumulative value of the artworks under the theory that if the entire collection of art was sold on the date of the father’s death, the estate would not be able to command the same price that it would have been able to command if it had separately placed each piece of art on the market. The taxpayer subsequently sold certain pieces of the collection. In reporting the gain on the sale of the artworks, the taxpayer used their undiscounted FMV as his adjusted basis alleging that the theory underlying the blockage discount at the father’s death was inapplicable to the separately placed sale of the artworks. The IRS assessed an income tax deficiency against the taxpayer alleging that the taxpayer’s adjusted basis in the artworks for purposes of determining gain or loss was the value of such art as reflected on the father’s estate tax return (i.e., adjusted basis reflected the blockage discount).
The Second Circuit, affirming the Tax Court (T.C. Memo. 2004-117 (May 12, 2004)), held that FMV for purposes of Sec. 1015 was the value of the property that appeared on the decedent’s estate tax return from which the property was transferred. In making its determination, the Second Circuit reasoned that Sec. 1015 prevents the double taxation of the appreciation in the value of property that occurred prior to death, noting that the estate tax taxes this unrealized capital gain. Without Sec. 1015, the unappreciated capital gain would be taxed a second time by the income tax. Based on this consistency, the Second Circuit held that Sec. 1015 only provides a step-up in the adjusted basis of property received from a decedent by the amount that is reflected on the decedent’s estate tax return. The taxpayer’s argument has some merit if one did not consider the Congressional intent in enacting Sec. 1015 (i.e., to prevent double taxation).
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