Joe Biden wants to cut a cherished tax break: Stepped-up basis for inherited property
Currently, a decedent’s unrealized gains aren’t hit with income tax at death, and heirs step up their basis in the assets they receive, equal to fair market value on death. Biden’s plan calls for an end to the effects of stepped-up basis for many wealthy individuals.
What would Biden’s proposal do exactly?
It doesn’t adopt a carryover basis regime by which the heir would take the same tax basis in the asset as the decedent. That rule applies to gifts.
It would instead treat death as a realization event for income tax purposes…essentially a deemed taxable sale of the decedent’s assets at fair market value, with any gains and losses reported on the decedent’s final individual tax return. The heirs would continue to get a fair-market-value basis in assets they receive.
Gains of less than $1 million would not be taxed. Plus other exceptions:
Property donated to charity would be exempt. Family-owned businesses and farms would escape tax, provided heirs run them. And the existing gain exclusion of $250,000 (or $500,000) on sales of primary residences would continue to apply.
Let’s illustrate the current rules and Biden’s proposal with a simple example
John’s mother owns stock that she bought years ago for $500,000. When his mom dies, John inherits the stock, which is worth $3 million. Under current law, neither John nor his mom owe income tax on the $2.5 million unrealized gain, and John’s basis in the shares is stepped up to $3 million. Let’s say John sells the stock five years later for $3.6 million. John pays tax at that time on his $600,000 long-term capital gain. If Biden’s proposal is enacted, the stock would be deemed sold upon the death of John’s mom. Her final tax return would reflect gain of $1.5 million ($2.5 million less $1 million exemption) and would show capital gains tax due from the deemed sale.
Taxing unrealized capital gains at death may sound simple, but it’s not
There are lots of complexities that come along with such a sea change: Figuring basis would be tricky, especially for non-marketable assets owned many years. Liquidity issues could lead to forced sales of assets to pay income tax due at death. Asset valuation. A slew of logistic and administrative difficulties. Last but not least, getting all Democrats on board to curtail one of the biggest tax breaks is not a given.