If another poster is putting out case law, regulations and statute, it isn't really appropriate to cite "Findlaw". Especially when it is not detailed on point and the poster makes a conclusion there is a difference between a lack of contribution on formation if there is a gift. (By the way, how else can there be a lack of contribution but for a gift?)
For an explination of the IRC sec. 2040, see the Regulations at Regs. Sec. 20.2040-1. Joint interests.
In, Patten v. United States, KTC 1997-184 (4th Cir. 1997), the question arose of the same type as mentioned in Hahn v. Commissioner. The appellate court listed the facts as:
"David Blaney, Taxpayer's husband, inherited the Property in 1952. On December 24, 1955, Blaney deeded the Property to himself and Taxpayer as tenants by the entirety. Blaney died on July 26, 1955), and Taxpayer became the sole owner of the Property. When Blaney died, the fair market value of the Property was $500,000. Blaney's estate included 50% of the value of the Property on his federal estate tax return.
In 1990, Taxpayer sold the Properly for $625,000. She reported a taxable gain from the sale of $199,133. 1 based on an adjusted basis of $256,982. Taxpayer died on June 16, 1993. Patten, the administrator of Taxpayer's estate, filed an amended return for 1990 and sought a refund of $127,384. Patten arrived at this figure in part by increasing Taxpayer's adjusted basis in the Property from $256,982, the amount originally claimed, to $500,000, the full fair market value of the Property at the time of Blaney's death."
The IRS felt that, although this was the correct result under previous law, the changes to IRC 2040 regarding spouses made the result incorrect and the wife should only get the step-up as you describe. (Again, this was a timing issue where the death is after the change, but the creation is before.)
The district court found Patten's calculation correct and the 4th circut affirmed.
In, Gallenstein v. United States, KTC 1992-31 (6th Cir. 1992), we have the same issue scenario with the fact summary of:
" On July 11, 1955, taxpayer and her husband purchased real property in Kentucky for $38,500, derived from her husband's earnings. The property was held in joint tenancy with right of survivorship. On December 12, 1987, taxpayer's husband died and she became sole owner of the farm. On July 5, 1988, Gallenstein sold 73.6 acres of the farm for $3,663,650. Under the terms of the purchase contract, taxpayer received $800,000 of the total purchase price in 1988, the remainder to be paid in installments over five years.
On her 1988 federal income tax return, Gallenstein initially reported a capital gain from the sale of the real estate based on net proceeds received from the sale in the amount of $3,659,596 and an adjusted basis of $103,000 1 with a resulting taxable gain of $3,556,596.
In May of 1989, taxpayer filed an amended federal income tax return for the 1988 tax year, reporting $1,838,685 as the adjusted basis for the property. This reduced the total realized gain from $3,556,596 to $1,815,725. Taxpayer therefore sought a refund of $105,395.
Gallenstein filed a second 1988 amended federal income tax return in August of 1989, on which she reported the full sale price of $3,663,650 as her adjusted basis in the farm property. This amount reflected an amended estate tax return filed by her husband's estate, claiming the full value of the property as includable in the decedent's gross estate. Because Gallenstein did not contribute toward the initial purchase of the farm in 1955, she received 100 percent of the property at the time of her husband's death. This resulted in a 100 percent step-up in basis under I.R.C. section 1014 and no gain to her from the sale of property in 1988. See I.R.C. section 1001(a). 2 Based on this amended return, taxpayer claimed a tax refund of $115,152 for the 1988 tax year.
The Internal Revenue Service accepted taxpayer's first amended income tax return for 1988 and paid taxpayer $105,187 (adjusted downward by the IRS in the amount of $208,000 as a tax refund). However, the IRS denied Gallenstein's second amended return and claim of a tax refund for $115,152, stating that pursuant to section 2040(b)(1) she could not receive a stepped-up basis for 100% of the property, but only for 50% of the property. Gallenstein brought suit in federal court, seeking a refund of federal income taxes, plus interest and costs. "
District found for wife and the 6th circut affirmed.