De Minimus rules
Due to 2008 sell off in the muni market many bonds with lower coupons are selling at deep discounts and are thus subject the de minimus rules. Without getting into the sordid details this means that gain that is realized either thru redemption or sale is treated as ordinary income instead of long term gain ( assuming > 1 yr )
My question has to to with an estate situation. If a bond owner dies does this discount get a step up OR is it an item of IRD? This is tricky because every rule I’ve read on this says that in a de minimus situation the gain is taxed as ordinary income. If the rules said it was tax as short term gain then I would feel confident it gets a step up…
Example … Owner buys at 70 and dies with price at 85. Is the difference between 70 and 85 stepped up or is it IRD? Also when the estate takes over the bond at 85 is the estate still subject to de mininimus rules?
Taking this a step further… some muni’s have a component of OID ( original issue discount) Is this component an item of IRD? I would tend to think yes on this one.
Permalink Submitted by mk foss on Tue, 2008-12-23 19:12
That’s a very interesting question. The rule is clear for Treasury bills, the growth between the original purchase price and the FMV at the date of death is IRD.
In the text that I have about preparing Form 706, there is no mention of the rule. I’ve come across the rule before but hadn’t heard it called “the de minimis rule” – it comes up when you prepare trust returns because it’s taxable income but not income for distribution purposes.
Permalink Submitted by Bruce Steiner on Tue, 2008-12-23 20:47
There seems to be some confusion among income tax, estate tax and fiduciary accounting.
Chuck is referring to the market discount rules in Sections 1276-1278. It used to be that if you bought a bond at a discount (because interest rates went up between the time the bond was issued and when you bought it), you could convert the discount into capital gain, even though to the new owner, the discount is the economic equivalent of interest. The market discount rules generally treat the discount as ordinary income. There is a de minimis exception in Section 1278(a)(2)(C) whereby the market discount is disregarded if it’s less than 0.25% per year.
If the owner dies, the new owner gets a new basis equal to the estate tax value under Section 1014.
For fiduciary accounting purposes, see the applicable state principal and income law.
A forum such as this can be useful for general information, but not for specific legal advice. If this involves an actual matter, you should consult the attorney handling the estate.