Tuesday, February 2, 2021

The Death Tax 2.0: Eliminating the Stepped-Up Basis

For many South Carolinians, their largest source of wealth is their home. When a family home transfers to an heir or heirs after a death has occurred, that transfer can represent a large amount of value. If the stepped-up basis for the purposes of capital gains is eliminated, the taxation of an inherited property will increase exponentially.

In accounting, basis is the starting point for calculating capital gains taxes. Think of basis as the asset’s purchase price: You owe taxes on capital gains above the basis. 


The Biden administration has made its intentions clear to raise estate taxes and capital gains to the extreme. Capital gains are profits made from the sale of either investments or properties. In the current structure, capital gains are taxes at a preferential rate that can be as low as 15%. The plan proposed by Biden would hike the long term capital gains tax to 39.6% for certain Americans, representing the largest increase in capital gains taxes in history. Why should you be concerned? This change would make selling property much more expensive for many property owners. 


Under the current laws, when a property owner dies, the cost basis of the property is stepped up to current market value. This provision essentially means the current value of the property becomes the basis. For example, suppose you inherit a house that was purchased twenty years ago for $40,000 and now it’s worth $240,000. You’d receive a step up from the original cost basis from $40,000 to $240,000. If you sell the property, you will not owe any capital gains taxes. 

The good news about capital gains on real estate is that the IRS typically allows you to exclude up to: $250,000 of capital gains on real estate if you’re single and $500,000 of capital gains on real estate if you’re married and filing jointly.

In 2017, the Trump administration doubled the federal estate tax exemption and indexed it for inflation. For the 2020 tax year, the federal tax exemption allowable is $11.58 million for singles and $23.16 million for couples. As long as your estate is valued at under the exemption amount, it will not pay any federal estate taxes, and the vast majority of estates do not owe any tax. 


Tommy Trantham, principle and owner of Trantham’s Tax and Financial in Bamberg, S.C. is wary of any changes to the stepped-up basis” If you lose the step-up in basis, then a lot of people are going to have to sell inherited property to pay the tax,” he said. “If Biden jumps the capital gain rate to 39.6%, you will get hammered when you do sell it. I’m praying it doesn’t come to that.” 


Insiders speculate that the Biden administration is considering a change in the triggering event for capital gains tax to be assessed. As it stands now, capital gains tax is assessed and paid when an asset like a home or tract of land is sold for a profit. Biden’s approach would seek to classify capital gains as realized whenever an asset or property changes hands, not necessarily at the occasion of a sale. It would happen any time the title changed, meaning heirs would likely have to pay capital gains taxes of up to 39.6% whenever the home or land passes on to the next heir. 


A report prepared for the South Carolina Department of Agriculture, the Palmetto AgriBusiness Council, South Carolina Farm Bureau and Clemson University Public Service Activities found that agriculture-related business is responsible for 9.1 percent of the economic activity in the state of South Carolina. In a small state like South Carolina, that percentage of agribusiness means a significant portion of land is used for farming.


This elimination of the stepped up basis and the change in triggering events for the payment of capital gains taxes would kill the agriculture industry and force family farms to sell out just to pay the taxes. To complicate matters, this tax would be in addition to an inheritance tax that could also be levied.


“You have to work this step up in basis with the unified credit, so there’s not going to be any estate income taxation. With the current eleven million per person exemption and the inherited property passing through at cost plus improvements versus market value at the date of death is a huge difference. If the Biden changes take effect, you’d have to sit on a property until another administration comes in and changes the rules before selling or willing it to an heir,” Trantham commented. 


“When you have estate income taxation, there’s not any because of the unified credit. If it was back at the one million dollar exemption where it used to be, any farmer that died, the family would have to sell the entire property to pay a tax bill. We sure don’t want to go back to those days,” he said.


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