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By Kenneth Kirk
For Senior Voice 

Death, taxes and stepping up to the plate


February 1, 2021 | View PDF

Deadlines are a funny thing.

Two months ago, I needed to get my Senior Voice column in, shortly after the election. So on the morning after election day, I took a quick look at the results, and it appeared we would have divided control of the federal government, with the Democrats controlling the White House and House of Representatives, and the Republicans controlling the Senate. So I wrote, in my column, that there would probably be no major tax changes for at least the next two years.

And then everything changed.

Now a lot of the advisors (not only estate planners like me, but stockbrokers, accountants and financial advisors) are wringing their hands and twittering that we will now see major tax changes. Actually some of them are rubbing their hands in glee, thinking they will have an excuse to squeeze their clients again because of all the planning that will have to be redone.

I am not so sure that will be the case. The Democrats have, literally, no margin in the Senate. They have exactly half the Senators, with the Vice President breaking the tie. If any one Democratic Senator refuses to go along with a bill for a large tax increase, it can’t pass. A lot of people in Washington are looking at Joe Manchin, a Democrat from relatively conservative West Virginia, to rein in some of the potential tax increases the new administration may want. And even if he caves in, there are other Senators whose votes would be needed, who have to run for re-election in purple states. They may not want to be associated with a huge tax hike.

But if the new regime in Washington does manage to get some kind of tax increase through, they have made it clear that one of their targets is going to be the “automatic step-up in basis on death”.

That’s a mouthful, isn’t it? It relates to capital gains tax, which is what you pay when you get something, and then you sell it for more. It is, simply put, a tax on profit.

Let me explain a few terms here. “Basis” is what you start with when you acquire an asset. In most cases, that is the purchase price. If I buy a rental property for $100,000, that is my basis. If I then spend $20,000 improving the property, that increases my basis, so I now have a basis of $120,000.

Let’s say that a couple years later, I turn around and sell that property and, after brokers fees and other costs of sale, I get $200,000. I subtract my basis of $120,000 from my proceeds of $200,000, and I have a profit of $80,000. The IRS calls this kind of profit a “capital gain”, and I have to pay a tax on that capital gain. If this is a long-term capital gain (meaning I held the property for at least a year before selling it) and I am in a typical middle-class tax bracket, I will probably pay about 15%. In other words, I have a tax bill of $12,000.

What if that property was a gift? What if my rich uncle quitclaimed the property to me, and I didn’t actually pay anything? In that case I have a “carryover basis”. That means that my basis is whatever my uncle had. If he bought it way back when for $40,000, and I just got $200,000 for it, I have to pay tax on $160,000. Making the same assumptions, I now have a tax bill of $24,000.

But it’s different if I inherited the property. If instead of making a gift, my rich uncle held on to the property until he died, and then I received the property either through probate, or a living trust, or a transfer-on-death deed, I don’t get a carryover basis. I get a much better deal called a “stepped-up basis”. That means my basis is whatever the property was worth on the date of my uncle’s death. If it was worth $200,000 on that day, and I turn around and sell it for that same price, I have no capital gains tax to pay.

So who has to pay the tax on the gain that the property had all those years my uncle was holding it? The answer is: nobody. That potential tax simply disappears.

This is one reason you want to think twice before giving assets to your heirs while you are alive, at least if those assets have gone up in value. If you give them the property, they are stuck with your basis. If you hold onto it and they inherit the property when you’re gone, they get a stepped-up basis.

At this point you might be thinking that it sounds only fair that the feds would eliminate the stepped-up basis on death. However, there is one other thing to consider. Let’s say my uncle bought that property way back in 1962. I probably won’t be able to find records of what he paid. And if I can’t prove up the purchase price, the whole thing becomes profit, because as far as the IRS is concerned, I have a basis of zero. That gives me a tax bill of $30,000.

Will this change happen? We will see. It is, I am sure, very tempting for those folks in Washington to eliminate this tax break. On the other hand, there a lot of people, not only here in Alaska but elsewhere, who acquired assets (typically real estate, but this applies to stocks and other investments as well) who would be pretty unhappy about it.

Kenneth Kirk is an Anchorage estate planning lawyer. Nothing in this article should be taken as legal advice for a specific situation; for specific advice you should consult a professional who can take all the facts into account. Y’all understand that these tax laws are very complicated and I am dramatically oversimplifying here, right?


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