Here’s how it works.
Suppose your parents own a home worth $200,000. They purchased the home decades ago for, say, $50,000. If they gift the home to you prior to their passing, your basis in the home is the same as theirs: $50,000. That means if you sell the home for its current value of $200,000, you must pay capital gains tax on the profit of $150,000 – the difference between basis and sale price.
By contrast, if you inherit the home after their death, your basis is equal to the fair market value of the property as of the date of death – in this example, $200,000. [See: IRS Code §1014(a)(1).] Now if you sell the property for $200,000, there is no capital-gains tax because there’s no gain (sale price minus basis equals gain).
This is what we refer to as the stepped-up basis. And the rule absolutely does not apply only to “rich people.” The operation of Code §1014 is not controlled by one’s annual income, the value of the inherited asset or the total value of one’s estate. It applies across the board. Every American taxpayer enjoys the benefit of stepped-up basis on inherited property.
If Code §1014 were repealed in its entirety, all gains on inherited property would be taxed at the capital-gains rate. In general, the gain would be calculated on the difference between the sale price and the price at which the deceased person paid for it (plus any capital improvements that add to the cost basis).
To go back to the parents’ home example: Let’s say the parents paid $50,000 for it originally, and transferred it to you before their death. Subsequently, you sell the house for $200,000; in that case, the $150,000 profit would be subject to capital gains tax. This is precisely what the Biden administration wants to eliminate the stepped-up basis rules to collect more taxes.
One possible consolation, however, is the White House has hinted it might be contemplating exempting the first $1 million in unrealized gains from these new rules. This would be nice, of course, but I will be quite surprised if President Biden and the Democrats actually do it. In addition, you can expect the capital gains tax bill to be calculated at a much higher rate than currently in effect.
The point is, the elimination of stepped-up basis will be a huge tax increase for millions of Americans – and not just wealthy people – despite Biden’s claims to the contrary.
Elimination of Stepped-up Basis Bad For Middle Class
According to Gallup, as of 2017, 82% of Americans over age 65 own their own homes. That is the highest rate of homeownership for any age group. When these people die, their property most often passes to their heirs. With Baby Boomers increasingly passing away in the next decade, economists and demographers predict a gigantic transfer of wealth in the years just ahead.
Yet if President Biden and the Democrats have their way, the coming huge wealth transfer will be: NOT from parents to children (as it should be) – but from parents to the federal government!
Senators Cory Booker (D-NJ), Chris Van Hollen (D-MD), Bernie Sanders (I-VT), Sheldon Whitehouse (D-RI) and Elizabeth Warren (D-MA) have announced a bill designed to close the stepped up basis tax provision.
changes increases being considered
- Corporate rate 21->28%
- Global min tax to 21%
- Top income rate to 39.6%
- End fossil fuel subsidies
- Tax investment gains > $1M as wage income
- Tax assets passed on at death