I inherited about $1 million worth of real property in 2010. The deceased's cost basis was approximately $200k. I know there was no estate tax in 2010 and I live in Connecticut, where I think the threshold for taxes on estates/inheritances is $2 million, so nothing there. My concern is capital gains, but I did read about a Tax Relief act that was passed at the end of 2010 and included something for estates where $1.3 million of basis can be added. 1) Is this correct? 2) Do I need to fill out some special forms to "take" the basis increase?. the estate is still open for other reasons and I am the executor and sole beneficiary and haven't taken title of the property yet.

The deceased cost basis is immaterial. YOUR cost basis is the appraised value at the time of death. Any tax liability will be based on that.

The rules for the estates of descendants who died in 2010 are different than for other years. Remember, that was the year that the federal estate tax was abolished. Consequently the normal "step up" rules were abolished for that year as well. In its place is a rule that gives the executor the ability to choose one of two methods for determining the cost basis of property passed on to heirs:

Option A. No estate tax is due (regardless of the size of the estate), and up to $1.3 million of the estate's property can be stepped up to market value as of the date of death ($3 million for assets going to a surviving spouse). It's the executor who makes this determination of how to apply this. As executor you need to file Form 8939 with the IRS to document the property's basis. However, it seems this particular form has not yet been finalized by the IRS - see:
Form 8939, Allocation of Increase in Basis for Property Acquired From a Decedent (http://www.irs.gov/formspubs/article/0,,id=218629,00.html)

Option B. Apply the new 2011 estate tax rules, which exempts up to $5M from estate taxes but provides step-up basis for all assets (similar to other years). If the total value of the estate is less than $5M this is probably the better way to go for you.

More info here: IRS Delays Guidance Regarding the Estates of People Who Died in 2010 (http://taxes.about.com/b/2011/04/01/irs-delays-guidance-regarding-the-estates-of-people-who-died-in-2010.htm)

Choices for 2010
For 2010, estates have two choices. Either pay no estate tax or pay 35% estate tax on assets over 5 million.
1. If you inherit property in 2010 from a estate that chose to avail unlimited estate tax exemption, the basis of inherited property remains the same as it was for the deceased owner. Your cost basis is not "step-up" but it is the "carry-over". However, you can choose to take your cost basis as "step-up" for only $1.3 million of the property. For any amount inherited over $1.3 million, your cost basis will be the smaller of the deceased owner's basis or the FMV on the date of the death. The surviving spouse will receive an additional $3 million basis "step-up".
2. If you inherit property in 2010 from a estate that is over 5 million and that paid 35% estate tax on assets over 5 million, you can claim stepped-up basis.

So the estate (total value under 1.3 million) does not pay any estate tax and the inheritor can claim stepped-up basis.

Thanks so much for the replies!

I thought that was the case as far as adding the 1.3 million to the basis, but you guys clarified that for me. Plus, I was unsure how to "do" that, so thanks ebaines for the links to the IRS forms and info, that helps much.

So in layman's terms the basis of the property to me is $1.3 million plus the decedents cost basis, so if I sell the property there won't be any capital gain unless it exceeds that amount.

As a follow-up question, this property consists of a house on some acreage and another contiguous (but, separate) parcel of acreage of about 20 acres. For estate purposes the house (and the land it's on) was appraised at $700k and the other piece of land at $300K. I've been negotiating with my town here about selling it (the 20 acre parcel) to them to preserve as open space probably for about $150k. So, the question is, is it possible I could get a tax credit for a donation (or loss) for the difference between fair market value (or cost basis per above) and the 150K if such a deal were to occur?

If you sell at a reduced price to the town, the difference between the selling price and the fair market value (FMV) can be considered as a charitable donation. You would have to have a certified appraisal of the property to document its FMV and file form 8283 with the IRS to take the deduction. Keep in mind that you can only deduct charitable contributions up to 50% of the amount of your adjusted gross income.