A new administration generally means new tax laws. So in these last few months, I’ve heard from many clients with questions about how the Biden presidency will affect them. I was recently asked about the potential repeal of the policy that allows step-up in basis, and wanted to share some thoughts with anyone who’s concerned about what this could mean.
One of President Biden’s earliest campaign promises was to fund the Biden administration’s healthcare plan by closing capital gains tax loopholes. Repealing the step-up in basis provision was just one element of that proposal. This provision affects how much capital gains tax you’ll have to pay after selling an inherited asset. If there’s any chance you’ll be inheriting and then selling property in the coming years, a change to this element of tax law could affect you.
I understand why people are anxious for answers about what to expect when it comes to how your tax situation might change. I can’t tell you what’s going to happen, but I can assure you that there’s no reason to worry just yet.
What to Know About Step-Up in Basis
If you’re not familiar with what step-up in basis means, here’s a quick overview. When you first buy an asset, for tax purposes its purchase price is called the asset’s basis. Many assets gain or lose value over time. When you sell an asset, the difference between its original purchase price and its sale price is called a capital gain (or a capital loss, if the asset sells for less than its purchase price).
Current tax law says that, when someone dies and one of their assets is transferred to their heir, the asset’s basis is automatically “stepped up,” or set at its current market value instead of the original purchase price. This means that, if the heir sells the asset, they only have to pay capital gains tax on any value the property gained after they took ownership.
Let’s say your mom bought a house in 1990 for $150,000. When she dies and leaves the house to you, it’s worth $400,000. At this point, the home’s basis is automatically stepped-up to $400,000. If you decide to sell the home for that price, you wouldn’t owe any capital gains tax because you sold it for the price it was worth when you inherited it. Without the step-up in basis, you may have owed capital gains tax on the $250,000 difference between your mom’s original purchase price and the sale price.
Maybe, instead of selling the home for its market value of $400,000, you decide to do some renovations and sell it the next year for $450,000. At that point, you may owe the capital gains tax on that $50,000 in added value—or you may not. The IRS allows a lifetime capital gains tax exemption of $250,000 per individual, or $500,000 for a married couple that files jointly. If you qualify for this exemption and haven’t yet used it, you may be able to apply your exemption to the sale and avoid paying the capital gains tax altogether.
Let’s say Congress were to pass a bill and repealing step-up in basis actually happened. You inherit and sell the $400,000 house, but its basis was still $150,000. If you don’t qualify for the exemption, in this scenario you may be responsible for the capital gains tax on the $250,000 difference. (The tax rate you would pay at that time would depend on how long you kept the home before selling it.)
My Advice For Heirs
I know that a lot of people are concerned about how changing tax laws may affect them over the next four or eight years. First, I want to assure you that it’s too soon to be worried about what changes may be coming because there are simply too many variables involved, and too many things that have to fall into place before this policy can be reversed.
Any tax bill that would repeal the step-up in basis would take time to make its way through Congress. Along the way, I believe there would be plenty of vocal opposition to this proposed change from both Democrats and Republicans. Repealing step-up in basis could be an unpopular choice with anyone who is looking ahead to an inheritance, since many beneficiaries would have a much bigger tax burden without the protection of this provision. This probably won’t be an easy fight for the new administration.
Furthermore, we don’t know what this theoretical bill would look like. Any number of compromises and/or exemptions could be built into new tax law, softening the blow of losing this benefit. We also don’t know when this law would go into effect, and how quickly it might be changed whenever the next administration is in office.
As a general rule, I recommend planning around the current laws and not giving too much weight to how they may change in the future. We’ve all seen how unpredictable our lawmakers can be. Instead of trying to anticipate what may happen next, just make sure you’re working with advisors who can help you adjust your plan when the law does change.
Right now, I’m advising clients not to worry too much about the step-up in basis until something definitive happens. I’ll certainly alert you well in advance of any tax law changes that affect you and your estate plans. In the meantime, feel free to reach out with specific questions. Contact me today!
Julie Ladimer is the founder of Ladimer Law. She has been helping people complete their estate planning since 2014. She has been named a Rising Star by Super Lawyers three years running and received a Boston Magazine Five Star Professional award.
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