Senator Christopher Van Hollen and Representative Bill Pascrell have introduced bills that would repeal the step-up in basis, which would result in the realization of capital gain when assets are transferred at death or by gift. President Biden supports the proposal as part of his American Families Plan, which we discussed previously in this post.
Current law provides that, when a person dies, the basis (value of an asset when it was initially acquired) of most of their assets is "stepped-up" to fair market value as of the date of death, thereby wiping out all of the prior appreciation from capital gains taxation if it is later sold by the person who inherited it. For example: if a parent bought a home for $100,000 and it is now worth $3 million, the heirs who inherit the property would pay no capital gains tax if they sold the property for its current value.
The topic is really controversial, getting the cold shoulder from both Democrats and Republicans, says Charles Schwab’s top Washington D.C. lobbyist.
I'll be attending a class on the topic this week and look forward to what the experts are saying about these proposals and how they may affect estate planning going forward. Below are a few of the key concepts that I expect will become common strategies in light of the potential loss of the step-up in basis.
1. Gifting Assets Before they Appreciate in Value
Under current law, it typically makes sense for an owner to hold appreciating assets until they pass away, avoiding the capital gains tax problem via the step-up in basis at death. If stepped-up basis is repealed, however, it may be more advantageous to give those assets away before they go up in value, thereby minimizing the capital gains tax that would apply later upon their death.
2. Owning Life Insurance
Permanent life insurance is a powerful and tax-efficient source of funds for estate planning. Because life insurance death benefits are not subject to income tax, no capital gains tax is due at the owner's death. The potential loss of the step-up in basis therefore makes life insurance even more attractive in terms of wealth transfer planning. Moreover, like insurance provides a guaranteed source of liquidity for any and all taxes that will be payable following a persons death. That is huge.
3. Making Large Gifts In 2021
Where appropriate, making large gifts to heirs this year before any new law would go into effect, and while the gift tax exemption is $11.7 million, may make good estate planning sense.