Step-up Basis at Expatriation for Foreign Assets
Step-up Basis at Expatriation: The concept of a step-up basis in the U.S. Tax system is a very familiar concept in estate planning law and tax. But, it also has a place when it comes to certain IRS expatriation asset values.
Here is the common situation many people are familiar with: David received a property from his grandma when she passed. Since he received it when she passed, the value is a stepped-up basis.
For example, if David’s sweet grandma purchased the property for $100,000, and now it is worth $800,000, when David receives the property through inheritance, his basis will be $800,000.
If instead, David’s Grandma gifted him the property during her lifetime, the carryover basis would only be $100,000 – the same as his grandma’s basis.
To compare, if David sells the property for $825,000, and can use the step-up basis, his adjusted basis is $800,000, and the gain is only $25,000 (unless it becomes his primary residence).
If instead, he used the carryover basis, he would potentially have to pay a gain of $725,000 since his basis would only be $100,000.
Expatriation & Step-Up Basis
With the concept of expatriation and step-up basis, it is the idea that if a U.S. person had assets prior to becoming a U.S. person, it would not be fair for the Internal Revenue Service to use the original basis as it was before that person became a U.S. person for the mark-to-market, unrealized gain analysis when then exiting the U.S. tax system.
As provided by the IRS in notice 2009-45, citing IRC 877 (A)
“Section 877A(h)(2) provides that, solely for purposes of determining the tax imposed by reason of section 877A(a), property that was held by a nonresident alien on the day that individual first became a resident of the United States (within the meaning of section 7701(b)) will be treated as having a basis on such date of not less than the fair market value of such property on such date. “
Example of Step-Up Basis & Expatriation
For example, Melinda purchased a property in Spain for $200,000 in 2004.
In 2013 she moved to the United States and became a U.S. person by obtaining a green card.
On the day she first became a resident, the property was worth $450,000.
For purposes of expatriation at a future date, the mark-to-market analysis she will use the $450,000 dollars value as the adjusted basis and not $200,000.”
“A covered expatriate to whom this basis adjustment rule applies may make an irrevocable election, on a property-by-property basis, not to have such rule apply. The election must be made on Form 8854, which must be filed with the covered expatriate’s Federal income tax return for the taxable year that includes the day before the expatriation date. See section 8 of this notice for information concerning Form 8854.”
The IRS and Treasury Department intend to exercise their regulatory authority to exclude from this step-up-in-basis rule United States real property interests within the meaning of section 897(c) (“USRPIs”) and property used or held for use in connection with the conduct of a trade or business within the United States.
Thus, if on the date the nonresident alien first became a resident of the United States, the nonresident alien held property that was a USRPI or was property used or held for use in connection with the conduct of a trade or business within the United States, then the basis of such property may not be stepped up to fair market value under 877A(h)(2).
If, however, prior to becoming a resident of the United States, the nonresident alien was a resident of a country with which the United States had an income tax treaty, and the nonresident alien held property used or held for use in connection with the conduct of a U.S. trade or business that was not carried on through a permanent establishment in the United States under the income tax treaty of such country and the United States, then that property is eligible for a step up in basis to fair market value under 877A(h)(2).
*The USRPI exception refers to certain property which is generally not eligible for step-up, unless the person resided as a nonresident alien in a country that had an income tax treaty with the U.S., and other conditions are met.
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