Except it doesn't work that way because cost basis gets reset during inheritance which is a huge give away to the most wealthy families. It is also the reason for an Estate Tax.
I'm not sure I understand the question. The assets in your estate get their cost basis reset to the current market value when your estate is passed on. That means the capital gains in his shares disappear.
That being said, the estate tax would kick in for everything over 11m, so he'd have to use other tricks to work around that limitation.
All assets within estate tax exemption limit $11.5M ($23M for married) receive a step-up basis on death. This means that cost basis resets to market value on the day you die, and your heirs can sell at market price the amount of money required to pay off the accumulated debt and start the cycle anew.
It's a bit similar to tax gain harvesting, which is when if you live in a no state income tax state and anticipate making very little income this year, but have some appreciated stocks, what you can do is harvest the tax gains by selling the stocks in order to reset to the higher cost basis and immediately buying them back. Since you have little income, you can get away paying $0 tax until $38.6k ($77.2k if married).
Not a tax accountant, but my understanding is that the cost basis gets reset when the property is inherited. If the home was already worth millions there wouldn't be any capital gains tax on it. (There only would be if prices go up more after inheritance.)
It's simplifying things a bit but basically the first $5.5/$11 million in total assets are Federal tax free. They are valued and taxed based on current market value and therefore the basis is stepped up to current market value at that time.
After the lifetime exclusion of $5.5/$11 (single vs married) million then any further inheritance is taxed around 40%.
Aren’t you omitting something here? Like the fact that the step up in basis happens after the inheritance tax is paid?
If I buy stock for $10 million and in 40 years it appreciates to $70 million (an average 5% annual growth), and then I die, my kids will pay inheritance tax on the $60 million capital gain. Then the new basis will become $70 million. What exactly do you propose it to be?
The estate gets a stepped up cost basis on the date of death. And then you pay the 40% federal inheritance tax and the 20% state inheritance tax on the total value at the date of death.
> if the cost basis is allowed to rise without paying any taxes (?!)
It's a common misconception that the step-up in basis means the heirs don't pay taxes, and therefore the billionaires are giving us the biggest shaft.
The heirs pay estate tax, and once they pay the tax, the basis resets. It would be very unfair if it didn't. However, the tax exemption for the estate tax is quite large (about $13MM for federal for 2023, but going to $7MM in 2026).
For billionaires though, the estate tax exemption is negligible. The heirs end up paying estate tax for everything they inherit minus $13MM, which is nothing for them.
So, again, if this benefits anyone, it's the less rich people.
I need to read more into that. If true, the cost basis should only be stepped up such that it accounts for the estate tax.
I'd prefer some simpler overall approach though. Removing step up in cost basis alone obviates the need for an estate tax, as eventually assets would be sold and tax revenue generated.
But important to do some research into how often inherited assets are kept permanently and gains never realized (thus tax never paid).
Just on gut instinct, I would guess most who inherit wealth eventually sell off any assets. I recall it tends to be that most accumulated wealth is lost by the third generation.
I think it would be perfectly reasonable to reset the basis on any asset which had 40% estate taxes paid on it, but that’s now how the law is written. Not only is there an $11 million lifetime exemption there’s also an annual gift tax exclusion that combined with some clever trust setups allow the wealthy to pass on much more than that without paying the 40%.
In practice huge amounts of capital gains are not taxed by either the capital gains tax or the estate tax.
So now we are in the weeds about inheritance tax, but the idea is that you pay 40% on your inheritance which clears your tax obligations for that inheritance and resets all the cost basis calculations, and then after that you pay gains when you sell from the time you inherited.
That is not a tax loophole.
E.g. if someone buys stock for $10, then the share price grows to $100 and they die, so that a family member receives $100 of stock, and then the share price goes up to $110 and the inheritor sells, then in the current system, the inheritor pays:
$40 on receipt of shares at $100 (cost basis for him is zero)
$4 on sale of shares at $110 (cost basis is now 100)
for $44 in taxes paid on that stock.
RSUs also work in the same way -- you pay taxes the moment you get them, and then if you keep them, when you sell your cost basis is the price of the shares when you were given them. That is important to know if you like to hold onto your RSU shares for a while -- know that your cost basis is not zero, but whatever the price of the shares were when you paid taxes for receiving them as income.
When you die, your estate pays taxes on the current value of the assets you’re passing along. Without stepped up basis, your heirs would get taxed again on gains that you essentially already paid a 40% tax on.
Interesting to me is that not-taxing inheritances is sort of a giant tax break. If your parent dies and they had bought a house for $100,00 and now it is worth $1,100,000. So a capital gain of $1,000,000. If they had sold the house they would have had to pay capital gains on the house, minus an exemption amount ($250,000 for single and $500,000 for married).
But you as the beneficiary get to take that house and immediately sell it and pay $0 in capital gains on it. So that tax is actually forgiven on death. If you held on to the house then you would pay capital gains on any gains from the value of it upon inheritance.
Critically, in years when estate taxes existed they treated cash identically to stocks so it was still a loophole. 13 million in appreciated assets counts the same as 13 million in cash. You only pay estate tax on the 80k over the $12.92 million threshold even their capital gains would have been 1.5 million that goes away.
If you inherit an asset your tax basis is its value when the owner died. This may be significantly less than what it is when you actually receive the asset, but it’s likely higher than when that person originally purchased it.
PS: Estates may chose an alternate date 6 months after someone died, which again generally helps.
But that doesn't prevent inheritance tax, which on a billion dollar fortune will exceed 50%. Even more if you die in places like NY or CA.
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