IRC Section 1014(e): One-Year Rule, Basis, and Form 8971 Reporting

The one-year rule in IRC Section 1014(e) shuts down a specific tax maneuver: gifting appreciated property to someone who is about to die so that it comes back with a stepped-up basis. If the decedent received the property as a gift within one year of death and it passes back to the donor or the donor’s spouse, the recipient does not get a fair-market-value basis. Instead, the basis stays at the decedent’s adjusted basis immediately before death, which usually traces back to the donor’s original low basis.

Without this rule, someone holding highly appreciated stock could hand it to a terminally ill relative, inherit it back weeks later at current market value, and sell with little or no capital gains tax. Section 1014(e) blocks that round-trip.

The Three Conditions That Trigger the Rule

All three of these have to be true before Section 1014(e) applies:¹

The property was appreciated at the moment it was gifted, meaning its fair market value on the gift date exceeded its adjusted basis.
The decedent received it as a gift during the one-year period ending on the date of death.
After the decedent died, the property (or its sale proceeds, in some cases) passed back to the donor or to the donor’s spouse.

The appreciation test is measured on the gift date, not the death date. Growth between the gift and the death doesn’t change whether the rule applies; what matters is whether there was already a built-in gain when the property changed hands.

A concrete example. You transfer a family farm with a $300,000 basis and a $2,000,000 market value to your elderly mother. She dies 11 months later, and the farm comes back to you through her will. All three conditions are met. Your basis in the farm is not $2,000,000. It is your mother’s adjusted basis immediately before her death, which is essentially your original $300,000 plus or minus any adjustments during her brief ownership.

How Your Basis Is Calculated

When the rule applies, your basis equals the decedent’s adjusted basis immediately before death.¹ In most cases, that traces back to the donor’s original carryover basis under Section 1015, adjusted for any depreciation the decedent claimed or capital improvements made during the short holding period.²

Suppose you gift stock with a $100,000 basis to your spouse. The stock is worth $1,000,000. Your spouse dies eight months later and the stock returns to you. Your basis under Section 1014(e) is roughly $100,000. Sell the stock the next day for $1,000,000 and you owe capital gains tax on $900,000 of gain. Without the one-year rule, you would have inherited a $1,000,000 basis and owed nothing on an immediate sale.

The result is the same whether the property comes back to the original donor or to the donor’s spouse. If you gift property to your dying parent and the parent’s will passes it to your spouse, Section 1014(e) still denies the step-up.

Who and What the Rule Does Not Reach

Section 1014(e) is narrow. It only denies the step-up when property lands back with the donor or the donor’s spouse. Anyone else who inherits the same property, including the donor’s children, siblings, other relatives, friends, or a charity, gets the normal fair-market-value basis under Section 1014(a).³

Say you gift stock with a $50,000 basis and a $500,000 market value to your terminally ill father. He dies six months later. If his will leaves the stock to you, your basis stays at roughly $50,000. If his will leaves the stock to your daughter, she inherits it with a $500,000 stepped-up basis. The one-year rule does not touch her. Whether the IRS would challenge a plan like that under the step transaction doctrine depends on the facts, but the plain text of the statute limits its reach to property returning to the donor or spouse.

Cash gifts sit outside the rule for a different reason. Cash cannot be appreciated property, because a dollar’s fair market value never exceeds its basis. A gift of cash to a dying relative that later comes back through the estate does not trigger Section 1014(e). If the relative uses the cash to buy an asset that then appreciates, what returns is a new investment eligible for the normal step-up, not the property that was originally gifted. Commentators have noted this gap. The step transaction doctrine could still be raised depending on the circumstances.

Indirect Routes: Estates, Trusts, and Retained Control

You cannot escape the rule by having the estate sell the property and hand the donor cash instead. Section 1014(e)(2)(B) applies the carryover basis rule to the extent the donor is entitled to proceeds from a sale by the decedent’s estate or a trust for which the decedent was the grantor.⁴

The IRS has also treated gifts as incomplete when the donor kept the power to revoke the transfer or otherwise maintained dominion over the property until the decedent died. In that situation, the IRS position in private letter rulings is that the gift did not occur until the moment of death, which by definition falls inside the one-year window. Fiduciaries handling estates with recently gifted assets need to track those transfers and the terms under which they were made.

Penalties for Claiming a Step-Up You Are Not Entitled To

Claiming a stepped-up basis when Section 1014(e) requires a carryover basis creates an underpayment of tax and exposes the filer to accuracy-related penalties under Section 6662.⁵ The base penalty is 20% of the underpayment. If you overstate basis by 150% or more of the correct amount, the substantial valuation misstatement rules apply. Overstating by 200% or more turns it into a gross valuation misstatement, and the penalty doubles to 40%. The substantial valuation misstatement penalty does not apply unless the underpayment attributable to the misstatement exceeds $5,000 ($10,000 for most corporations).

The numbers get large quickly. On a correct basis of $100,000 that gets reported as a stepped-up $1,000,000, a sale at $1,000,000 understates gain by $900,000. At a 20% long-term capital gains rate, that is $180,000 in unpaid tax. A 40% penalty on top adds another $72,000. Section 6662 also specifically targets inconsistent estate basis reporting, where a beneficiary reports a basis that does not match what the estate reported to the IRS.⁵

Reporting: Why Section 1014(e) Property Is Excepted From Form 8971

Executors of estates required to file Form 706 must also file Form 8971 and furnish Schedule A to each beneficiary, reporting the value and basis of inherited property.⁶ The IRS instructions classify property described in Section 1014(e) as excepted property, so it is not reported on Schedule A. That exception exists because the step-up does not apply to this property in the first place, so there is nothing consistent-basis reporting needs to police. It does not mean the carryover basis rule is optional. The donor is still on the hook for using the correct basis when they eventually sell.

The substantive Section 1014(e) rule applies regardless of whether the estate is large enough to owe federal estate tax or file Form 706 at all. Reporting obligations and the basis rule are separate questions, and the basis rule is the one that determines what you owe when the property is sold.

1
Office of the Law Revision Counsel. 26 USC 1014 – Basis of Property Acquired From a Decedent – Section: Appreciated Property Acquired by Decedent by Gift Within 1 Year of Death
2
Office of the Law Revision Counsel. 26 USC 1015 – Basis of Property Acquired by Gifts and Transfers in Trust
3
Office of the Law Revision Counsel. 26 USC 1014 – Basis of Property Acquired From a Decedent
4
Office of the Law Revision Counsel. 26 USC 1014 – Basis of Property Acquired From a Decedent – Section: Treatment of Certain Property Sold by Estate
5
Office of the Law Revision Counsel. 26 USC 6662 – Imposition of Accuracy-Related Penalty on Underpayments
6
Internal Revenue Service. Instructions for Form 8971 and Schedule A