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August 1993

Spousal jointly owned property: a new step-up in basis. (Estates & Trusts)

by Smith, Michael F.

    Abstract- A recent case illustrates how a surviving spouse can receive a step-up in basis for 100% of the value of spousal jointly owned property. In the 'Gallenstein v. US' case, the Kentucky District Court ruled that the surviving partner is qualified for a step-up in basis on the entire property value. It decided that the whole jointly-held property value that was purchased in 1955 can be included in the gross estate of the decedent, who passed away in 1987, due to the fact that the deceased provided all the consideration for the property. The court judged that the effective data of the Tax Reform Act 1976 provision which states that half of the value of qualified joint interests generated after 1976 can be included in a decedent's gross estate was not altered by the provisions of the Economic Recovery Tax Act of 1981. This means that the 'contribution test' provided by IRC 2040(a) can be applied to decedent's estate.

Community Property Rules

In community-property states, the husband and wife are considered as each owning one-half of the estate (excluding separate property). When one spouse dies the surviving spouse is regarded as acquiring one-half of the community property by devise, bequest, or inheritance. Therefore, the surviving spouse gets a step-up in basis in one-half of the community property.

The basis of the other half of the community property that passes to the surviving spouse is also stepped-up (IRC Sec. 1014(a)(6)). The result is that if the surviving spouse inherits the deceased spouse's share of the community property, 100% of the property receives a basis step-up (or step-down) to the fair market value at the date of death or the alternate valuation date. (See "Community Property Step-Up in Basis," The CPA Journal, May 1993)

New Exception

Now there is another exception. In a September 1991 case in the U.S. District Court in Kentucky, the plaintiff, Mrs. M. Lee Gallenstein, received a step-up in basis of 100% of the property she and her deceased husband owned as joint tenants with right of survivorship (Gallenstein v. United States, 91-2 USTC 60,088 (D.C. Ky)). The court found that the full value of jointly held property acquired in 1955 was includable in the gross estate of the decedent who died in 1987 because he provided all the consideration for the property. Therefore, his surviving spouse was entitled to a step-up in basis on the full value of the property, not on one-half. The court found that the effective date of the provision in TRA 76 providing that 50% of the value of qualified joint interests created after 1976 was includible in a decedent's gross estate was not changed by the ERTA 81. Therefore, the "contribution test" of IRC 2040(a) was applicable to the estate of the decedent.

Taxpayer's Stance

In 1955, Mr. Gallenstein purchased real property jointly, with right of survivorship, for $38,500 with funds derived from his earnings. At the time of his death in 1987, the property was worth $3.7 million. Mrs. Gallenstein subsequently sold the property in 1988 and in an amended 1988 return she reported the adjusted basis of the property at $3.7 million. She contended that since the joint interest was created before 1977, IRC Sec. 2040(a) required the full value of the property to be included in her deceased husband's gross estate, with the result of a step-up in basis on 100% of the property. IRC Sec. 2040(a) provides as follows:

"The value of the gross estate shall include the value of all property to the extent of the interest therein held as joint tenants with right of survivorship by the decedent and any other person...in their joint names and payable to either or the survivor, except such part thereof as may be shown to have originally belonged to such other person and never to have been received or acquired by the latter from the decedent for less than an adequate and full consideration in money or in money's worth."

IRS' Position

On the other hand, the IRS maintained that only one-half of the value of the property should be included in the estate under IRC Sec. 2040(b). This sub-section was added to the Code by TRA 76 and amended in 1981 by ERTA. The provision, as enacted by TRA 76, provided that one-half of the value of "qualified joint interest" property is includible in the estate of the first spouse to die. The amendment applies to joint interests created after December 31, 1976.

The amendment by ERTA replaced the definition of a qualified joint interest. Additionally, and more importantly, the IRS took the position that ERTA repealed by implication the effective date of IRC Sec. 2040(b) as enacted by TRA 76. Therefore, the qualified joint interest rule of IRC Sec. 2040(b) applied to all joint interests of decedents dying after 1981, irrespective of the date of creation of the joint interest. The result in the instant case would have been a step-up for only one-half of the value of the property. They argued that the legislative history of the act established that Congress intended to adopt an easily administered rule for all spousal joint interests which would eliminate the burdensome tracing requirements of IRC Sec. 2040(a). Mrs. Gallenstein, however, maintained that the doctrine of implied repeal is not appropriate because the plain language of the statutes at issue is not in conflict.

Applicable Law

The court maintained that the language of the statutes is the best indication of legislative intent. They further stated that when there is no ambiguity in the language of statutes, resorting to the legislative history to interpret such language would be unnecessary and improper. Additionally, a new statute will not be read as partially repealing a prior statute unless a "positive repugnancy" exists between the two.

The court pointed out that the cardinal rule of statutory construction does not favor repeal by implication. However, implied repeals are allowed where 1) provisions in two acts are in irreconcilable conflict, therein the later act repeals the former or 2) the later act covers the whole subject of the former and is clearly intended as a replacement. But, in either case the intent of the legislature to repeal must be clear and manifest.

Court's Decision

The court concluded that 1) the 1976 and 1981 provisions were not in irreconcilable conflict and 2) the 1981 provision did not cover the whole subject of the 1976 provision. Thus, the court held that the test for finding an implied repeal of the effective date of IRC Sec. 2040(b) was not satisfied and ERTA did not change the non-applicability of this provision to pre-1977 joint interests. The court found for the plaintiff and directed the IRS to pay all costs, expenses, and attorney's fees.

Tax Saving Idea

The court's decision was affirmed in September 1992 by the U.S. Court of Appeals for the Sixth Circuit. This now creates a real opportunity to save tax dollars. Where its application would give a higher basis because the spouse who supplied the consideration for the pre-1977 purchase died first and an income tax was imposed on the subsequent sale of the property, a refund claim should be filed before the statute of limitation expires. Also, the Gallenstein case should be kept in mind when developing current estate plans. It should be noted, however, that the benefit of Gallenstein is not available where an election under the former provisions of IRC Sec. 2040(d) was made. This election, which had to be made during 1977, 1978, or 1979, allowed pre-1977 joint interests to be treated as qualified joint interest property governed by IRC Sec. 2040(b).

Editor's note: For an in-depth discussion see "Community Property Step- up in Basis' by Richard K. Toolson, appearing in the May issue of The CPA Journal.

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