Proposed Changes to Stepped Up Basis Law – What Is It and Why Does It Matter?
With the looming expiration of the 2017 Tax Cuts and Jobs Act (TCJA) at the end of the year, one of the proposals being floated by the current administration is the complete repeal of the estate tax. The estate tax exemption presently stands at $13.99 million per individual (just under $28 million per couple). But if it is not extended or made permanent by the end of the year, exemption is set to decrease to around $7 million per individual.
While repeal of the estate tax may sound great, even at the lower exemption level it affects very few individuals and families. Estimates say that the estate tax, even with a reduced exemption amount, would affect less than 1% of the U.S. population. But there is another part of the proposal that would have a much broader impact and that is the elimination of the step-up in basis.
While determining tax basis can get very complicated, the original tax basis of an asset is often the cost paid for the asset. If you bought a parcel of raw land for $10,000, that is your tax basis. If you improve the land, that will increase your tax basis. If you then depreciate the improvements on your tax return, that will decrease your basis. Upon sale of the property, the gain is then taxed at the capital gains rates. Assuming at the time of sale the tax basis is still $10,000 and you sell the property for $300,000, your taxable gain is the difference between your tax basis and the sales price, or $290,000. Pretty straight forward.
Where it really gets interesting is when people start giving assets away during life or at their death. If instead of selling the real estate, you give it to someone else during your lifetime, the general rule is that your income tax basis “carries over” to the recipient. This is known as carry-over basis. Therefore, in our example, their basis would also be $10,000 and if they then sell for $300,000 they will likewise have $290,000 of taxable gain.
If instead of giving it away while you are alive, you wait until your death to transfer ownership, the potential gain (or loss) on the sale of the property is eliminated and the estate or heirs take the property with a new income tax basis equal to the fair market value of the property at the date of death. This is known as stepped-up basis. Therefore, if you pass the property described above to your heirs at your death and the fair market value is $300,000, the new tax basis is $300,000. If the property is then sold for $300,000, there is no taxable gain.
It is estimated that the basis adjustment saved taxpayers of all levels of wealth in excess of $40 billion while the revenue from estate and gift tax in 2023 was only $34 billion by comparison. Therefore, while one tax is eliminated, it was only paid by a relatively small number of people. On the other hand, if you weren’t one of the fortunate folks to be wealthy enough to pay an estate tax, your family may now have to deal with capital gains taxes that were previously eliminated meaning your total tax bill actually went up.
This post is for informational purposes only and not for the purpose of providing legal advice. You should contact an attorney to obtain advice with respect to any particular issue or problem. Nothing herein creates an attorney-client relationship between Hallock & Hallock and the reader.