Barack Obama's administration called the stepped-up basis rule "perhaps the single largest loophole in the entire individual income-tax code." Hillary Clinton calls it a "loophole, which lets the highest-income Americans escape paying their fair share on assets passed to heirs." While these kinds of descriptions make out the stepped-up basis rule to be some kind of nefarious loophole only used by the most wealthy, the reality is that the stepped-up basis rule is just as important to those in the lower and middle classes.
What is Basis?:
To understand the "stepped-up" basis rule, it is important that you first understand what "basis" is. Basis is an integral part of determining profit, or what the tax code calls "gain," for items that you sell. Without being too complex, basis is generally the amount that you paid for an asset. Your profit, or "gain" is the difference between your basis (the price you bought the item for) and the amount you sold the item for. The gain is considered income and you are taxed on that amount.
Think of it like a merchant who buys low and sells high:
What is the stepped-up basis rule?
The stepped-up basis rule says that when you pass away, the basis for all property you own is changed to be equal to the full-market value of the property as of the day you die. This results in less tax when the property is sold.
To use the antique example from earlier:
While it is true that this results in a boon for those with large sums of money (since the basis is changed on all of their property, including their stocks, their real estate, and their other investments,) this also has a large impact on those in the lower classes.
How does the stepped-up basis rule impact lower and middle-class families?
One of the largest assets that most people hold is their home. Over the past ten years, the median values of homes in Wisconsin has fluctuated between $115,000 and $175,000. For those who have lived in their homes for a significant amount of time, values for the property have generally gone up over the years.
To use a personal example, my parents have lived in a house purchased in 1970 that has increased in value from $10,000 to an assessed value of $100,000. They are not well-to-do, and this house is a significant portion of their total assets. So imagine, if the basis rules were changed, and they passed away, there would be $90,000 in gain to be taxed.
Worse yet, the tax rules would incentivize them to move out of the house that they have lived in for over the past 45 years! Currently, when you sell a homestead that you have lived in for two of the past five years, there is no tax on the gain if the home is worth less than $250,000 (for an individual) or $500,000 (for a couple). In short, my parents would be faced with a choice; continue living in their home, and force a tax when they die, or sell the home and avoid taxation on $90,000 worth of gain.
While I imagine that some legislation would be issued to prevent this perverse incentive, I am still concerned with the way that the stepped-up basis rule has been discussed in political discourse. So, take this as a reminder, when you are reading political messages, be wary of what they say. You never know how you might be impacted by laws you had no idea existed.
--Attorney Derrick Heller-Neal
What is Basis?:
To understand the "stepped-up" basis rule, it is important that you first understand what "basis" is. Basis is an integral part of determining profit, or what the tax code calls "gain," for items that you sell. Without being too complex, basis is generally the amount that you paid for an asset. Your profit, or "gain" is the difference between your basis (the price you bought the item for) and the amount you sold the item for. The gain is considered income and you are taxed on that amount.
Think of it like a merchant who buys low and sells high:
- You buy an antique for $10 (Basis)
- You sell the antique for $20 (Sales Price)
- Your Gain is $10 (Sales Price of $20 minus Basis of $10)
- You will be taxed on your $10 of income
What is the stepped-up basis rule?
The stepped-up basis rule says that when you pass away, the basis for all property you own is changed to be equal to the full-market value of the property as of the day you die. This results in less tax when the property is sold.
To use the antique example from earlier:
- You buy an antique for $10 (Basis)
- Instead of selling the antique while you are still alive, you pass away when the antique is worth $20
- The antique's basis is changed to be $20
- Your spouse or children sell the antique for $20
- Your Gain is $0 (Sales Price of $20 minus Basis of $20)
- You will receive no tax, since there is no gain
While it is true that this results in a boon for those with large sums of money (since the basis is changed on all of their property, including their stocks, their real estate, and their other investments,) this also has a large impact on those in the lower classes.
How does the stepped-up basis rule impact lower and middle-class families?
One of the largest assets that most people hold is their home. Over the past ten years, the median values of homes in Wisconsin has fluctuated between $115,000 and $175,000. For those who have lived in their homes for a significant amount of time, values for the property have generally gone up over the years.
To use a personal example, my parents have lived in a house purchased in 1970 that has increased in value from $10,000 to an assessed value of $100,000. They are not well-to-do, and this house is a significant portion of their total assets. So imagine, if the basis rules were changed, and they passed away, there would be $90,000 in gain to be taxed.
Worse yet, the tax rules would incentivize them to move out of the house that they have lived in for over the past 45 years! Currently, when you sell a homestead that you have lived in for two of the past five years, there is no tax on the gain if the home is worth less than $250,000 (for an individual) or $500,000 (for a couple). In short, my parents would be faced with a choice; continue living in their home, and force a tax when they die, or sell the home and avoid taxation on $90,000 worth of gain.
While I imagine that some legislation would be issued to prevent this perverse incentive, I am still concerned with the way that the stepped-up basis rule has been discussed in political discourse. So, take this as a reminder, when you are reading political messages, be wary of what they say. You never know how you might be impacted by laws you had no idea existed.
--Attorney Derrick Heller-Neal