Calculating Your Expatriation Tax Basis (A Step Up For Some Expats)

Generally, no step-up in basis

The question came up about a step-up in basis for assets when a person becomes a U.S. resident. The general rule is that no such step-up is given.

Example

Fred bought land in France for EUR 100,000 in 1996. In 2010 the land is worth EUR 400,000. Fred becomes a resident of the United States in 2010, then sells the land. For U.S. capital gain tax purposes, Fred has a capital gain of EUR 300,000 (converted to USD of course).

Exception for expatriates

Kate Leonard, who was on the webinar from San Diego, though -- reminded me of a special exception to this rule. The exception is for people who are "covered expatriates" and give up their green cards or citizenship. (Thanks, Kate).

If you become a U.S. permanent resident, stay that way for at least eight years, then give up your permanent resident status, you are subject to the exit tax rules. The exit tax is basically a "mark to market" exercise -- pretend you're selling all of your assets and pay U.S. income tax accordingly (first $600,000 exempt, other exceptions, blah blah blah).

Strictly for the purpose of that "mark to market" calculation, you will get a step-up in basis for your assets at the time you get your green card.

Notice 2009-85

Notice 2009-85, Section 3(D) is the source for this position:

D. In-bound step-up in basis for nonresident aliens becoming resident aliens

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. 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).

Example 4. A first became a resident of the United States when A became a lawful permanent resident (green card holder) on April 1, 1995. On April 1, 1995, A owned Asset S with a basis of $ 400X and a fair market value of $ 700X and Asset T with a basis of $ 500X and a fair market value of $ 300X. Neither Asset S nor Asset T is a USRPI or property used or held for use in connection with the conduct of a trade or business within the United States. On June 30, 2010, the fair market value of Asset S is $ 1,300X and the fair market value of Asset T is $ 800X. On July 1, 2010, A ceases to be a lawful permanent resident and becomes a covered expatriate within the meaning of section 877A(g)(1)(A). A does not make the irrevocable election not to have the rule of section 877A(h)(2) apply. Therefore, Assets S and T will each be treated for purposes of the mark-to-market regime as having a basis of not less than the fair market value on April 1, 1995, so that Assets S and T will be treated as having a basis of $ 700X and $ 500X, respectively, on June 30, 2010, for purposes of determining the tax under section 877A(a). A will be deemed to realize $ 600X ($ 1,300X -$ 700X) of gain with respect to Asset S and $ 300X ($ 800X -$ 500X) of gain with respect to Asset T, for a total of $ 900X.

Example 5. The facts are the same as in Example 4. If A makes an irrevocable election on Form 8854 not to have the rule of section 877A(h)(2) apply with respect to Asset S because A does not want to incur the expense of having an appraisal conducted with respect to Asset S's fair market value on April 1, 1995, A will be deemed to realize $ 900X ($ 1,300X - $ 400X) of gain with respect to Asset S.

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