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Message
Capital Gains at Death
Posted on 1/21/15 at 1:18 pm
Posted on 1/21/15 at 1:18 pm
(I'm posting this on the Money Talk board as opposed to the Political Talk board, in hopes a logical and decent discussion can be had here)
Capital Gains
As many of you probably know and the article explains, assets transferred at death take on a new basis - the FMV of the asset at death. The unrealized gain that happened between the time the asset was acquired, and death, is never taxed. If it was sold the day before death, it would be taxed.
As an example, guy buys Google stock for $10,000. When he dies, it's worth $50,000. He leaves the stock to his son. His son takes a basis of $50,000 in the stock, and only pays tax on the gain north of $50,000, when the son sells it. The $40,000 of gain built up before death is never taxed.
Now, this makes perfect sense in a world with a low estate tax exemption - like we had pre-2000. Why? Because the estate tax is based on the full value of the asset at the time of death. So, while no one pays capital gain tax on the $40,000 gain... the estate potentially - if the estate exceeded the exemption - pay estate tax on the full $50,000 - and estate tax is higher than capital gains tax.
Now, with an exemption north of $5 million... as a matter of fairness - should we relook at this?
Any asset that is subject to estate tax should get a full step-up in basis. However, for assets that are not taxed at the estate level - I can see a reason for not stepping up the basis. Thus, when the heir sells the stock - the heir would pay the entire capital gains tax - both for the growth under the decedent and the growth under the heir. Which, again, the heir gets all the money from the sale of the stock.
Just curious what other people think about this.
Capital Gains
As many of you probably know and the article explains, assets transferred at death take on a new basis - the FMV of the asset at death. The unrealized gain that happened between the time the asset was acquired, and death, is never taxed. If it was sold the day before death, it would be taxed.
As an example, guy buys Google stock for $10,000. When he dies, it's worth $50,000. He leaves the stock to his son. His son takes a basis of $50,000 in the stock, and only pays tax on the gain north of $50,000, when the son sells it. The $40,000 of gain built up before death is never taxed.
Now, this makes perfect sense in a world with a low estate tax exemption - like we had pre-2000. Why? Because the estate tax is based on the full value of the asset at the time of death. So, while no one pays capital gain tax on the $40,000 gain... the estate potentially - if the estate exceeded the exemption - pay estate tax on the full $50,000 - and estate tax is higher than capital gains tax.
Now, with an exemption north of $5 million... as a matter of fairness - should we relook at this?
Any asset that is subject to estate tax should get a full step-up in basis. However, for assets that are not taxed at the estate level - I can see a reason for not stepping up the basis. Thus, when the heir sells the stock - the heir would pay the entire capital gains tax - both for the growth under the decedent and the growth under the heir. Which, again, the heir gets all the money from the sale of the stock.
Just curious what other people think about this.
4
Posted on 1/21/15 at 1:30 pm to LSUFanHouston
1. Estate and Gift Tax makes up less than 0.5% of the federal tax receipts. Any changes to those laws with the purpose of increasing revenue is purely driven by class warfare. It will do nothing for our economy.
2. If I inherit something, I shouldn't have to sell it to pay the damn estate taxes. If I do sell it, now you want to tax me based on what my dead relative paid for it back in the day? Also class warfare against anyone whose family has left something for their kids.
2. If I inherit something, I shouldn't have to sell it to pay the damn estate taxes. If I do sell it, now you want to tax me based on what my dead relative paid for it back in the day? Also class warfare against anyone whose family has left something for their kids.
Posted on 1/21/15 at 1:52 pm to Bear Is Dead
quote:
If I inherit something, I shouldn't have to sell it to pay the damn estate taxes. If I do sell it, now you want to tax me based on what my dead relative paid for it back in the day? Also class warfare against anyone whose family has left something for their kids.
That's not what I'm suggesting. I am saying, keep the estate tax exemption as is. When and if you do sell the stock down the road, you pay the capital gains tax based on the entire gain.
If the dead relative sold it the day before he died, and left you the cash, he'd have to pay capital gains tax on it, right?
In other words, the fact that someone died should not cause an item to not be taxed, if it would have been taxed had the person died and not sold it.
My personal feeling on the estate tax is that it is unfair and punitive and should be eliminated. But this is a different story.
Posted on 1/21/15 at 2:27 pm to LSUFanHouston
quote:
That's not what I'm suggesting. I am saying, keep the estate tax exemption as is. When and if you do sell the stock down the road, you pay the capital gains tax based on the entire gain.
It is what you are suggesting, you just don't have malice in your heart like the president. Fact is that people inhereit real estate, which then has to be sold in order to pay the estate taxes. Yes I know there is a 5.25mil exemption, but for someone who just inherited a lot of land, how does it feel to have to sell that land to pay the tax bill?
quote:
If the dead relative sold it the day before he died, and left you the cash, he'd have to pay capital gains tax on it, right?
That's correct
quote:
In other words, the fact that someone died should not cause an item to not be taxed, if it would have been taxed had the person died and not sold it.
But that is the effect. The heirs will sell the property to pay the tax bill on the total amount inherited, and then with no step-up in basis, they will be taxed on the gain that goes all the way back to its original acquisition.
quote:
My personal feeling on the estate tax is that it is unfair and punitive and should be eliminated. But this is a different story.
It is immoral. It doesn't in any way effect the federal budget. The only reason to change it is to redistribute wealth. That's it.
Posted on 1/21/15 at 2:32 pm to Bear Is Dead
quote:
But that is the effect. The heirs will sell the property to pay the tax bill on the total amount inherited, and then with no step-up in basis, they will be taxed on the gain that goes all the way back to its original acquisition.
If estate tax is paid on an asset, then the step up should be granted.
Under my idea, it would be an either/or. Either you pay estate tax on an asset at death and get a step-up, or, you would pay capital gains tax on an asset at full gain when it's actually sold.
If your real estate example, if they are subject to the estate tax, then nothing changes from current practice. If they are not subject to the estate tax, they only are subject to capital gain tax when the real estate is sold.
Posted on 1/21/15 at 2:39 pm to LSUFanHouston
I would prefer there be zero estate tax regardless of amount of wealth inherited with the assets being inherited continuing to have the same cost basis of the deceased person.
So whenever the heirs sell, they will pay capital gains on the assets sold just as if the deceased person was still alive and had sold those assets.
So whenever the heirs sell, they will pay capital gains on the assets sold just as if the deceased person was still alive and had sold those assets.
Posted on 1/21/15 at 2:47 pm to LSURussian
+1
Posted on 1/21/15 at 2:47 pm to LSURussian
quote:
I would prefer there be zero estate tax regardless of amount of wealth inherited with the assets being inherited continuing to have the same cost basis of the deceased person.
Difficulties with establishing basis would be a huge issue if this was the rule.
Posted on 1/21/15 at 2:53 pm to LSURussian
quote:
whenever the heirs sell, they will pay capital gains on the assets sold just as if the deceased person was still alive and had sold those assets.
I guess it makes sense this way, it just makes some assets inherited almost unsellable.
My grandfather had 200 shares of XOM when he retired in 1968- my mother inherited 1600 shares (6400 total shares divided by 4 kids)in 2005 when he died. So if she sold her stock now, she'd pay 15% on 1550 shares, then 15% on the difference between what he paid and what the stock is worth now on the remaining 50 shares? Is that right?
Posted on 1/21/15 at 3:04 pm to LSUFanHouston
I'm not really sure where I come down on this.
On the one hand, the current situation of (effectively) no Estate Tax plus a stepped-up basis disincentivizes an older person from making an otherwise beneficial transaction (Where person owns X, thinks Y will be more valuable than X 10 years after his death even after cap gains on X, but holds on to X because he anticipates that at his death X will be worth more than [Y less Cap Gains on selling X]).
On the other hand, not allowing a step-up basis might keep property in the same family basically forever, because with each generation the tax hit from selling gets bigger and bigger.
On the one hand, the current situation of (effectively) no Estate Tax plus a stepped-up basis disincentivizes an older person from making an otherwise beneficial transaction (Where person owns X, thinks Y will be more valuable than X 10 years after his death even after cap gains on X, but holds on to X because he anticipates that at his death X will be worth more than [Y less Cap Gains on selling X]).
On the other hand, not allowing a step-up basis might keep property in the same family basically forever, because with each generation the tax hit from selling gets bigger and bigger.
Posted on 1/21/15 at 3:04 pm to LSUFanHouston
I don't think there should be a capital gains tax.
Consumption taxes reduce cheating.
Consumption taxes reduce cheating.
Posted on 1/21/15 at 3:09 pm to ThisWayChad
quote:Why?
Difficulties with establishing basis would be a huge issue if this was the rule.
With today's electronic storage of financial data and transactions, it would be easily accomplished especially if the tax rules were clearly communicated so that everyone would know what their responsibility is when they inherit something.
As for as the person who said my idea would make it almost impossible for assets to be sold because of the tax consequences, that, to me, is not as important as today's system which almost forces some heirs to sell assets in order to pay taxes.
Choosing to keep assets is better than forced to sell, IMO.
Posted on 1/21/15 at 3:25 pm to makersmark1
quote:
I don't think there should be a capital gains tax.
Hell Yes
ETA: By hell yes, I mean no taxes on the sale of an asset. Not eliminating the benefit of the separate tax.
This post was edited on 1/21/15 at 3:27 pm
Posted on 1/21/15 at 3:46 pm to LSUGUMBO
quote:
I guess it makes sense this way, it just makes some assets inherited almost unsellable.
My grandfather had 200 shares of XOM when he retired in 1968- my mother inherited 1600 shares (6400 total shares divided by 4 kids)in 2005 when he died. So if she sold her stock now, she'd pay 15% on 1550 shares, then 15% on the difference between what he paid and what the stock is worth now on the remaining 50 shares? Is that right?
Eghh, not sure how you are coming up with these numbers.
Keeping track of the cost basis is no more difficult for heirs than it is for people who aquire stock multiple times over a period of time. Your grandfather would have had to know his cost basis for tax purposes if he sold, so your mother should be able to find it as well.
In your example, your mother would inherit the cost basis that your grandfather had. Cost basis for stock is generally quoted as a whole, lump-sum, but in reality it can be broken down to a per share number. Get that number and your mother can pay the taxes.
As for the OP, my take is similar to Russian's. If I buy XOM @ $100/share, that cost basis will remain for those shares until someone sells them. The seller will pay the taxes.
I often see clients who hold their stock assets longer than they intended because they are pressued by their heirs. Heirs are sitting around waiting for death so they can sell mom's Exxon stock for themselves. There is a problem with that IMO.
Posted on 1/21/15 at 3:50 pm to LSUFanHouston
How does a legatee determine the decedents adjusted basis in a closely held business interest? Do you know what your great grandfather paid for a family heirloom that you inherited but want to sell because it has no sentimental value to you?
You might as well assign zero basis and holding period to all inherited assets. Two problems that immediately come to mind. First, inherited cash would then result in an immediate tax liability at ordinary rates. Second, what happens if I own 500 shares of IBM, I inherit another 500 shares, and subsequently sell 200 shares of IBM? What ordering rules should apply to the shares I sold?
You might as well assign zero basis and holding period to all inherited assets. Two problems that immediately come to mind. First, inherited cash would then result in an immediate tax liability at ordinary rates. Second, what happens if I own 500 shares of IBM, I inherit another 500 shares, and subsequently sell 200 shares of IBM? What ordering rules should apply to the shares I sold?
Posted on 1/21/15 at 3:57 pm to Poodlebrain
Good points Poodle. Obviously determing the cost basis for stocks is considerably easier than for other assets. Perhaps they could be treated separately?
As for your second question, doesn't the IRS allow you to stipulate your ordering in some cases? I thought there were provisions for some distributions for qualified plans where you simply tell the IRS how you're going to do it? I could be way out of touch though.
As for your second question, doesn't the IRS allow you to stipulate your ordering in some cases? I thought there were provisions for some distributions for qualified plans where you simply tell the IRS how you're going to do it? I could be way out of touch though.
Posted on 1/21/15 at 3:58 pm to LSURussian
quote:
As for as the person who said my idea would make it almost impossible for assets to be sold because of the tax consequences, that, to me, is not as important as today's system which almost forces some heirs to sell assets in order to pay taxes.
Choosing to keep assets is better than forced to sell, IMO.
I don't disagree, I wasn't trying to argue that estate taxes are better than carrying over a basis.
My comment was the OPs point that estate taxes at current levels being effectively zero for most estates. With even minimal estate planning it isn't hard to keep an estate under $10MM on paper. Anyone having to sell property to pay estate taxes under current law is either absurdly wealthy or had a terrible, terrible accountant, and either way while I'm not endorsing current practices I'm just not very sympathetic.
Basically, I just think its bad for an elderly person to hold onto something he doesn't really want just because he bought it for cheap, and I also think its bad for someone to hold on to an asset they don't really want just because their great-great-grandfather bought it for cheap.
So, I am against everything and everyone is wrong.
This post was edited on 1/21/15 at 4:09 pm
Posted on 1/21/15 at 4:16 pm to Bear Is Dead
The real estate is the real big issue here. Most of the time if you have held income producing real estate long enough then the cost basis is reduced to zero.
If you are investing in real estate then you more than likely will keep leverage (loans) on the property so you can continue to grow a portfolio by reallocating your equity in property elsewhere.
Eventually there is no way to sell the property because the basis can actually be negative and the net proceeds after the loan is paid off will be used almost exclusively for taxes. In some cases the tax is more than the proceeds.
This is from an article I found that shows the point. For example your dad dies and leaves you his real estate. It has a fair market value of $1,000,000 and is subject to a mortgage of $800,000. Thus, the equity is worth $200,000. Also assume the property has a cost basis of $50,000. If the property were sold, the gain subject to income tax would be $950,000 resulting in income tax of approximately $237,000 assuming a combined state and Federal tax rate of 25%. Under that scenario, the tax would be $37,500 greater than the equity. To dispose of that property, the owner would have to come "out of pocket" to pay the taxes. If it were possible to transfer that property to heirs, absent a basis step up, you would be transferring a net liability after taking into account income taxes. Contrast this with the estate tax liability (assuming a 50% rate). The estate tax would be $100,000, $137,000 less than the income tax liability inherent in the asset.
The only option left is for the property to be passed on to heirs at a stepped up basis.
If you are investing in real estate then you more than likely will keep leverage (loans) on the property so you can continue to grow a portfolio by reallocating your equity in property elsewhere.
Eventually there is no way to sell the property because the basis can actually be negative and the net proceeds after the loan is paid off will be used almost exclusively for taxes. In some cases the tax is more than the proceeds.
This is from an article I found that shows the point. For example your dad dies and leaves you his real estate. It has a fair market value of $1,000,000 and is subject to a mortgage of $800,000. Thus, the equity is worth $200,000. Also assume the property has a cost basis of $50,000. If the property were sold, the gain subject to income tax would be $950,000 resulting in income tax of approximately $237,000 assuming a combined state and Federal tax rate of 25%. Under that scenario, the tax would be $37,500 greater than the equity. To dispose of that property, the owner would have to come "out of pocket" to pay the taxes. If it were possible to transfer that property to heirs, absent a basis step up, you would be transferring a net liability after taking into account income taxes. Contrast this with the estate tax liability (assuming a 50% rate). The estate tax would be $100,000, $137,000 less than the income tax liability inherent in the asset.
The only option left is for the property to be passed on to heirs at a stepped up basis.
Posted on 1/21/15 at 4:18 pm to Poodlebrain
quote:
How does a legatee determine the decedents adjusted basis in a closely held business interest? Do you know what your great grandfather paid for a family heirloom that you inherited but want to sell because it has no sentimental value to you?
Well, for starters, it's up to the seller of an asset to show basis, right? In the absence of that, the basis is zero.
But the rule would only apply for assets transferred at death after the enactment of the new law. So if Allen started a company, who left it at his death to Bill, and then Bill dies after enactment of new law and leaves it to Charlie... your closely held situation would be very easy to figure out. Charlie would take a basis equal to the adjusted basis in Bill's hands when Bill died. Since Bill just died... it should be pretty easy to determine his basis - it's the stepped up basis Bill received when Allen died, plus/minus adjustments to basis while Bill held the interest.
quote:
You might as well assign zero basis and holding period to all inherited assets. Two problems that immediately come to mind. First, inherited cash would then result in an immediate tax liability at ordinary rates.
How can cash have a basis that is not equal to FMV? The basis of cash is always $1 for each $1 of cash held.
quote:
Second, what happens if I own 500 shares of IBM, I inherit another 500 shares, and subsequently sell 200 shares of IBM? What ordering rules should apply to the shares I sold?
This would be the same treatment as two blocks of shares that were purchased at different times by the same person.
Posted on 1/21/15 at 4:27 pm to Maderan
quote:
basis can actually be negative
Basis can never go below zero.
As for the example you gave... think about economically.
There can only be a few reasons I can think of to have that big of a difference between debt and basis:
1) At least one 1031 exchange has occured, in which case, the taxpayer upon sale is really recognizing the gain on more than one property
2) A relatively recent loan was taken against the property, maybe in a refinance, and the proceeds were not capitalized back in the property, and instead where used on other property.
3) Same as two, but instead of using it on another property, it was used on the subject property, but ordinary expense deductions were taken (maybe a bunch of repairs written off).
The owner may be coming out of pocket to pay the tax, but the owner has enjoyed greater tax deductions over the years. Truly, the time to pay the piper has come.
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