Capital Gains Taxes for Estates
When planning or administering the estate, one of the many kind of taxes to consider is capital gains tax. Capital gains are a type of income, but are taxed differently than ordinary income, such as wages.
What are capital gains?
Capital gains are, essentially, the amount you make when you sell something for more than you paid for it. Let's use a home as an example: you might have paid $30,000 for a house in 1950 and, today, that house could be worth $180,000. The $30,000 is considered your 'tax basis.' If you sold your house, you'd have $150,000 in capital gain using the following formula: sale price - tax basis. Of, course, the federal government and IRS regulate this particular area of law, so it's not that simple; many other rules apply.
Step Up in Basis
Capital gains are calculated (and taxed) using the sale price - tax basis formula. There's a law out there that, when someone passes away, the estate's asset's basis is increased to the fair market value at the time of that person's death. If you sell the asset shortly thereafter, it will probably sell for the fair market value. That means the sale price and the tax basis are now the same. So, if the capital gain is sale price - tax basis, there would be no capital gain and, thus, no capital gain tax!
When planning your estate, you can take advantage of this law by continuing to hold a capital asset until your death instead of selling it beforehand and realizing a gain.
Political Future of Step Up
President Obama, in his latest State of the Union address, proposed closing a tax 'trust-fund' loophole that affects only a small portion of Americans (the wealthiest portion). This loophole was speaking of the step up in basis. I'm not a political expert so I can't predict whether the house, senate, and president could all agree on such a change, but I can say that it's currently in the crosshairs of at least one major branch of government. I can also say with a fair amount of confidence that removing the step up law affects more the small portion of wealthiest Americans. Even families of moderate means are likely to have some assets that have gained significantly over the years.
Also worth noting is the homestead exemption, since homes are a large assets for many families. This allows an exclusion of $250,000 for a single person or $500,000 for a married couple filing jointly in the sale of a primary home (and a couple other conditions). This amount generally covers the gain in many situations.
Cornerstone Law, LLC does not provide legal advice through this website; legal advice, by its very nature, requires a full understanding of your personal situation and can change from jurisdiction (your location) to jurisdiction. This website does not intend to provide legal advice, but instead, provide a general background education on different legal topics. If you would like legal advice, please contact Cornerstone here.