Biden to eliminate the step-up in basis loophole...does this affect the little guys?

Politics & Elections
1

There is an atrocious but apparently somewhat factual copypasta making its way around Facbook deriding Biden for his plan to remove the step-up basis. I won’t dignify it with a link (it’s partisan hackery) but the gist is this: “Dummy Dems did this to themselves! When you inherit your dead dad’s house you’re going to have to pay taxes on it for the accrued value based on what it is worth now vs what your dad paid for it.” It then lists some examples.

So IRL in my case I am heir to my family’s home. It was purchased in the 90s for 17k. But it is now valued at nearly $300,k (those are my blood, sweat and tears, too). This copypasta says when my folks kick off and I inherit the house, I’ll have to pay taxes on the difference ($283,000).

The comments are always completely aghast, clutch pearls and moan “why, that’s outrageous! I’ll have to sell my pops house just to cover the taxes to inherit it in the first place!!”

Politifact doesn’t go into the nuances/details of the post, but does say it’s mostly correct because Biden does have a proposal to eliminate the step-up in basis.

However, I’ve read another 6 articles and I still cannot make hide nor hair of whether this affects me, or even MOST people.

Right now it’s my understanding that passing an estate worth 1million or less is easy breezy and tax free. In 2019, the Capital Gains Tax was doubled to allow for exemptions $11.58m and below, meaning the rich could transfer wealth without consequence.

Biden wants to go back and lower it to $5m or so. So as I see it, unless you inherit over 5mill, this doesn’t affect you.

So my understanding:

less than 1 million: NO taxes/no inheritance taxes, easy transfer.

Between 1.0001 million and 4.9999 million: You pay inheritance tax but not Capital gains tax.

Over 5 million (or whatever they decide): “some steeper tax liability I don’t understand”

Can anyone break this down for me…and explain if your every-day Joe American is going to have to pay taxes on the difference between a cheap house in the 50s vs inflated modern prices?

2

As I understand the proposal, this affects you when you sell the house.

For example, if your folks bought the house for $17K and it is worth $300K when you inherit it, you would owe nothing in estate tax (assuming the house plus the rest of the estate doesn’t go over $11.7 million and you don’t live in a state with its own inheritance tax). Biden’s proposal won’t change that.

When you go to sell the house (say, for $400K in another decade), under current law you’d owe capital gains on $100K ($400K sales price minus $300K step-up basis). Under Biden’s proposal, you’d owe capital gains on $383K ($400K sales price minus $17K original purchase price). That isn’t due unless/until you sell the house, though.

(Also, there are ways to minimize that capital gains tax bill when you do sell. In particular, if the house is your primary residence for at least two of the five years preceding your selling it, most people can exclude at least some of the capital gains; married couples are usually entitled to exclude $500K. Also, capital improvements made to the home and certain expenses associated with purchase and sale, such as real estate commissions, are figured in: if you sold the house for $400K but had to pay $20K in sales expenses, you use $380K as the final value.)

3

My first thought is that I want this the be something done by legislation not by an executive order. I hated the shallowness of the one paragraph with no thought decree that took away the power to tax from the legislature. I am sad that the beginning of this administration is doing the same, although it is mostly revoking the worst of the last few years.
I think there are different types of assets that can be treated differently. Business assets should have records that show the costs and depreciation taken. There is no justification for a step up basis. Stocks are tracked much better now and can be taxed when sold. Personal residence probably will be harder to value and the IRS doesn’t want to get into that mess any more then they want to decide which parent claims a child. A step up value for that could still work.
Taxes will only be due when a asset is sold so no sobbing about “having to sell”
Assets that are left to multiple heirs may be messier but that has always been true.

4

I really don’t like it when people use “loophole” for absolutely everything they don’t like, or someone doesn’t like, about tax law. This is not some hidden arcane rule, or people managing to craft a transaction such that the tax law applies to it in a way the law didn’t intend. This is how things work, and how things have worked.

I can only imagine that it exists because of the difficulty of record-keeping over multiple generations. If you bought the asset, then you should, theoretically, know everything that went into it, and know where all the paperwork is. If you obtain an asset as a gift, the donor is at least still alive to be able to inform you as to the basis of the gift you received. If you inherit something though, how in the world are you supposed to find out the basis of something that might have a long complicated history? Perhaps there is paperwork somewhere, but how are you supposed to know? And if there isn’t paperwork, why should the IRS be allowed to default and say there’s zero basis since you can’t prove anything?

This has been suggested in the past, but it’s simply unworkable as policy due to record-keeping requirements being unenforceable on other people. If somehow everyone became an expert at record keeping, then it would be possible, but you can’t penalize people with respect to taxes when someone else makes a mistake. It needs to be uniform and not depend on the situation.

It’s not going anywhere by executive order, because it’s not an interpretation of the law by the Exective Branch. It simply is the law. It would have to be changed by Congress. Sure, it would likely get through in reconciliation if a workable plan was found, but it’s not changeable by executive order.

5

Yes, stepped-up basis is the law, and would have to be changed by legislation, maybe as part of a reconciliation bill.

And when the stepped-up basis was made law (~40 years ago, IIRC), the record-keeping problem was a real one. If your 94 year old aunt died in 1983 and her safe-deposit box at the bank held certificates representing shares of stock bought at some way earlier date where even the decade couldn’t be determined, then whaddaya do?

But for the past few decades, all that would have been recorded on computers at the brokerage that handled the purchase, and at the issuing corporation itself. Any stock purchase too far back to show up on such records could simply be assigned a basis of the stock’s average price between 1980 and 1990, or something like that.

Mostly, the stepped-up basis is one more sweet gift to rich people’s children who don’t need a handout, but are getting a gold-plated one in this law.

If the stepped-up basis is still intact when my mother dies, my sisters and I will benefit quite nicely from it, incidentally, because she owns much stock that was bought decades ago. But what’s the cap gains tax these days, 20%? Well, 80% of the value of my share of that stock will still be pretty sweet. I can live with that. And the stepped-up basis shouldn’t be kept because someone, somewhere might find themselves in dire straits because their inheritance is taxed at 20% when they sell it.

Now AFAIAC, there’s no reason for capital gains to be taxed as anything other than regular income, but that’s a whole 'nother debate.

6

It will (and must) be changed by law, if it is changed.

This is true, but it’s not the whole story. Many countries don’t have step-up basis, so it’s not a universal thing. And until relatively recently the estate tax provided a rationale for the step-up basis. If the entire estate is taxed it makes sense that the after-tax portion be stepped up in basis for those that inherit the assets.

I’ve always thought that the real unfairness is the combination of a gigantic estate tax exemption plus the step-up basis. This allows for a significant amount of multi-generational wealth to avoid taxation completely. We should either have rather more modest estate tax exemptions, which brings with it incentivization of tax avoidance schemes, or we should remove the step-up basis so that at least at some point the revenue is collected, but which brings with it record-keeping difficulties

Because ultimately we have to decide what the most efficient means of collecting tax revenue is. By efficient I mean the one that has the fewest negative economic impact, most accurately captures externalities, and encourages a productive society. It seems to me that taxing the capital gains on inherited assets is a perfect example of a non-distortive, relatively painless method of funding the government.