The stepped-up basis for our children is under attack. The Biden administration wants to either abolish the stepped-up basis altogether or alter it to generate more tax dollars. If heirs are then forced to pay a capital gains tax upon inheriting an asset, despite not selling, this could have negative consequences for families and the economy.
The stepped-up basis is a way of adjusting the tax rate paid on capital gains, which may be hiked for those who make over $1 million in combined income and capital gains. Although paying a capital gains tax rate of 39.6% + 3.8% NIIT tax may sound like a lot, eliminating the stepped-up basis would be far worse. The stepped-up basis applies to investment assets passed on after death.
When someone inherits capital assets such as real estate, stocks, bonds, or a small business, the IRS “steps up” the cost basis of these properties to the current “fair market value.” Fair market value is easier to determine for publicly traded assets. However, deciding the fair market value for real estate, private equity, or a small family business is much more subjective.
Under current tax law, when an inherited asset is sold, the inheritor only pays tax on any profits calculated from the day they inherited it. Therefore, if the asset value is stepped up to its current market value and immediately sold, the heir doesn’t have to pay any capital gains tax.
Let’s first go through an example of a stepped-up basis and then the risks of relying on the stepped-up basis to pass down assets. Then I’ll share some examples demonstrating why we need to preserve the stepped-up basis for our children. If you are an estate planner or tax lawyer, please chime in!