The Tangible Property Regulations (TPRs) and Stepped-up Basis Issues
Addressing potential tax deduction issues before an elderly person dies is essential to maximize tax savings, minimize the tax burden on beneficiaries, and ensure that deductions are not lost. Proactive planning allows for the full utilization of potential TPR deductions and proper management of income taxes.
The tax basis of all assets held by a taxpayer at the time of death is generally adjusted to the fair market value at the date of death, or the alternative valuation date (AVD), if elected. Although this concept is referred to as a “stepped-up” basis, infrequently it will be a “stepped-down” basis. In this discussion we focus only on the “stepped-up” basis issues. We also do not address any estate tax issue on the stepped-up basis as well. If the estate won't be taxable (the current lifetime gift/estate tax exemption is $13.99 million per person in 2025), it could make more sense to retain the asset and receive the stepped-up value.
A stepped-up value of real estate eliminates or supersedes the basis in the hands of the deceased taxpayer and removes any capital gains tax an heir would otherwise owe on the property if the property is sold. Step-up in basis is often referred to as a tax loophole because of the advantage it often offers people who inherit assets. This provision is codified in the Internal Revenue Code §1014, Basis of Property Acquired from a Decedent, and is intended to eliminate the potential of double taxation (e.g., income taxes and estate taxes) on a deceased person's estate.
Due to the stepped-up rule, the basis of the real estate before the death of a decedent does not really matter. In other words, if in the application of the TPRs the taxpayer is able to take advantage of tax deductions for capitalized prior year work efforts that should not have been capitalized those available TPR tax deductions have no effect on the eventual step-up in basis. In fact, if the taxpayer does not take advantage of the available TPR deductions before the date of death, those TPR deductions are lost forever.
Let’s look at an example of this – Bob, age 85, owns Main Street Apartments (MSA) which has a current fair value of $2,000,000. Upon this death, Bob has his will set up for the apartment complex to go to his son and daughter. MSA has significant taxable rental income annually. Bob’s current basis in MSA is $1,000,000 of which $100,000 could be realized as a tax deduction should Bob implement the TPRs. That $100,000 TPR deduction will save Bob around $40,000 in income taxes. If Bob dies before the TPRs are implemented on his tax return, that $100,000 TPR deduction will be eclipsed by the stepped-up basis and essentially be “lost”.
To avoid this situation, all taxpayers, but especially elderly taxpayers, that have significant taxable income, should be sure to take advantage of tax deductions that the TPRs offer. The only way to be sure that this situation is not present is to obtain a TPR study to see if the taxpayers detailed depreciation schedule presents TPR deduction opportunities.
