A new administration usually means that tax code changes are coming. While it remains unclear exactly what tax changes President Biden’s administration will usher in, two possibilities are that he will propose lowering the estate tax exemption and eliminating the stepped-up basis on death. The first would affect only multi-millionaires, but the second could have an impact on more modest estates and their heirs.
In 2017, Republicans in Congress and President Trump doubled the federal estate tax exemption and indexed it for inflation. For the 2020 tax year, the exemption is $11.58 million for individuals 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. President Biden has expressed an interest in lowering the estate tax exemption. It could be halved to $5 million or even reduced to the previous exemption of $3.5 million for individuals.
Another possible tax change is to how property is valued when it is passed on at death. “Basis” is monetary value of an item for determing gains for tax purposes and is typically the cost of the property (the “cost basis”). Adjustments to basis may happen over time due to various things such as capital improvements or depreciation (“adjusted basis”). When determining whether a capital gains tax is owed on property, the basis is used to determine whether an asset has increased or decreased in value by subtracting the adjusted basis from the amount received for the asset. If you have a positive number, there is a gain, and conversely, if you have a negative number, there is a loss. For example, if you purchase a rental house for $100,000, that is the cost basis. Assuming you have not made any capital improvements or taken any depreciation deductions, when you sell the property for $500,000 5 years later, you will have to pay capital gains taxes on the $400,000 increase in value .
Under current law, when a property owner dies, the heirs inherit the property with a basis that is “stepped up” to the current fair Marcet value of the property. For example, suppose you inherit that rental house that was purchased 5 years ago for $100,000, but it is now worth $500,000. Your tax basis for the rental property will be equal to the $500,000 fair Marcet value. If you sell the property right away, you will not be subject to any capital gains taxes.
According to an article in the New York Times, the current administration may propose to eliminate the basis step-up rule. Using the example above and a 20% capital gains tax rate, you would be subject to an $80,000 tax liability on the $500,000 rental property you received.
Another question is whether either of these changes will be made retroactively. It is unlikely, but possible, that if Congress changes these rules later in the year, they could be made retroactive to the first of the year. If you are concerned about these rules changing, a trust may be a good way to protect your estate. Property in a trust passes outside of probate, and there are specific types of trusts that are designed to protect assets against estate taxes and capital gains. Talk to an attorney at the Law Offices of Marc A. Bronstein to determine if a trust is right for you.
Tax experts agree that while changes to the tax code are likely, they probably won’t happen right away. The coronavirus pandemic and the recession it has triggered mean that Congress has other priorities at the moment.