The idea behind the proposed repeal of a step-up in basis is to change the tax treatment of deferred assets; particularly those assets passed onto one’s heirs after death. There are pros and cons, and the CREM Group brings the analysis to our readers so they can know what might be ahead as they look to selling their families’ homes in or out of probate. The step-up in basis can affect the taxable estate, defined in our searchable glossary of terms.
What is the step-up in basis?
The tax foundation defines it this way: “The step-up in basis provision adjusts the value, or “cost basis,” of an inherited asset (stocks, bonds, real estate, etc.) when it is passed on, after death. This often reduces the capital gains tax owed by the recipient. The cost basis receives a “step-up” to its fair market value or the price at which the good would be sold or purchased in a fair market. This eliminates the capital gain that occurred between the original purchase of the asset and the heir’s acquisition, reducing the heir’s tax liability.”
What is “basis”?
An asset’s purchase price is usually referred to as that asset’s basis. When figuring capital gains, or losses, capital gains are referring to the difference between the asset’s purchase price (its basis) and its selling price. From a tax standpoint, the capital gains tax is not due until the taxpayer realizes a capital gain—that is, when they sell the asset for a profit. As people in “the biz,” we at the CREM Group are fully aware that some assets (in our case, real property) are kept for generations and transferred from their original owners to their heirs. If these beneficiaries never sell their families’ assets, the assets will not be subject to capital gains taxes. “Under current federal tax policy, the capital gains tax rate applies only to profits from the sale of assets held for more than a year, referred to as long-term capital gains. ”
As investors (homeowners are investors) purchase and retain assets over time, the asset values fluctuate. Under our current federal tax law, the tax basis of property transferred to an heir at the owner’s death is increased to its current market value based on professional comparisons in the geographical surroundings. By “stepping-up” the basis (the original purchase price) to the present—usually increased—marketplace selling price, any appreciation in the property’s value that happened during the original investor’s lifetime goes untaxed. If the heirs choose to sell the asset, a resulting tax liability would be figured on the (usually) higher basis. In that case, the basis cost is higher, the profit on the sale is less, and the difference would result in a lower (long or short term) capital gains tax. For homes, it’s usually a long-term capital gains situation.
Pros and Cons of Repealing the Step-up in Basis
While repealing the step-up in basis would raise substantial revenue compared to current law, it would, at the same time, reduce national saving and overall wealth. The job of clarifying and then analyzing the effects of the tax changes leads to increased compliance costs for taxpayers and the government.
A step-up in basis encourages people to hang on to their assets. Why? Because each time the asset changes hands without selling, no profits are realized, and the increased cost gets passed on to the heirs. Eliminating step-up in basis would result in higher gains on the sale of the property, thereby increasing heirs’ tax burdens while also growing federal revenues.
The step-up in tax basis favors beneficiaries by reducing their overall tax liability. Conversely, repealing the step-up in basis would make tax liabilities from the sale of inherited assets more in line with taxes for income and gifts. Revenues would go up. So would costs. The repeal would likely cause an increase in auditing fees for the Internal Revenue Service (IRS).
Who does it affect?
Overall, a repeal in the step-up basis might be viewed as a move that applies to wealthy individuals who own huge estates, and lots of stocks and bonds. But the repeal does not just pertain to the “super-rich.” The top one percent of taxpayers would be affected the most, and the top 20% second most. Middle-income people with modest estates would be affected, increasing their taxes, but not increasing federal tax revenue enough to make much difference.
Repeal would undoubtedly raise the cost of compliance to taxpayers, as they would have to substantiate the original cost of every asset against the sale price to state the gain accurately. The calculation is especially complicated when the decedent has not left the correct (or any) documentation regarding the assets’ original costs. For the moment, the paperwork burden would be a huge imposition. On the positive side, with some forewarning, families in the future (should the repeal go through) would be more careful in documenting their original purchase prices.
As outlined, repealing the step-up in basis would have varying effects on the taxes paid by beneficiaries of probate, conservatorship, and trust sales. Actually, any asset sales. It’s interesting to note that the proposal to repeal is not new. According to this source, “step-up in basis has been eliminated twice during the past 50 years, and each time, the change was short-lived.” History says one thing. But that was then and this is now.
We cannot make a prediction, but we have an opinion. If the repeal goes through, then without lowering the capital gains tax rate, repealing the step-up in basis would increase the tax burden on savings accounts, reduce the total share of income earned by Americans, and shrink our overall wealth. We hope the proposal to repeal the step-up basis does not gain traction—at least at this moment in time. The United States has more significant problems, the pandemic being one, and our economy, jobs, homelessness, and education are others that each need all of our attention. Our country has been through enough upheaval. Small businesses in particular are still struggling after COVID-19. Let’s let the repeal issue go for now so we can concentrate on more important issues.
Keep coming back, and contact us if you have any thoughts or questions. Meanwhile, we will let you know if we hear of any change on the proposed repeal.
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We at the CREM Group have been handling probate real estate transactions for both residential and commercial properties in Los Angeles and Orange Counties for years now. We try to ensure that we support our clients so they know the legal and tax aspects of selling their probate, trust, and conservatorship homes in California. We also try to make our readers aware of many trends in real estate and related issues.
As always, contact us by email here if you have any questions about real estate, probate real estate, conservatorship, or trust real estate properties, especially in Los Angeles and Orange Counties in California.
Mark Cianciulli, Esq.
Daniel Taylor, Esq.
DISCLAIMER: This content is meant purely for educational purposes. It contains only general information about real estate and related matters. It is NOT legal advice and should not be treated as such. We recommend consulting a legal or tax professional before acting on any material, opinion, or point of view described herein.
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