Stepped Up Basis Exemption at Risk!

Biden Tax Plan eyes eliminating the stepped-up basis exemption as part of tax reform efforts

A little-known provision in the Biden administration’s tax plan could easily have millions of middle-class Americans paying much more in taxes. “One way the Biden tax plan may try to raise revenue to fund the administration’s $3 trillion infrastructure bill is by changing the way capital gains taxes are administered at death.” So write Taylor Tepper & Benjamin Curry in a Forbes Advisor column. That change would be of what is called ‘stepped-up basis’. Today, heirs are not taxed on the appreciation or gain in the value of a home or investments that took place before they inherited the asset.

However, a proposed provision in the Biden tax plan could leave children and heirs liable for capital gains taxes. Democrat Senators Corey Booker and Chris Van Hollen and Independent Bernie Sanders have proposed a bill to close what they say would close the stepped-up basis tax loophole. That could have a significant impact on middle-class families who would face having to pay capital gains.

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Joe Kimball May 3, 2021 at 11:22 am

My understanding of the Step Up tax rule is not affected by a loan on the property. If this is true, passing on part of the equity now through a reverse mortgage will not eliminate the tax impact (should this tax law be removed) for the heirs. It may in fact further hurt them if they were not wise with the funds the parents passed on early since the tax would be due, but the equity to pay the tax may have been distributed and spent.

James E. Veale, CPA, MBT May 3, 2021 at 2:00 pm

Although your premise is logical, it is incorrect.

It is clear in this case that what the heir should do immediately upon notification of the potential transfer of property is to disclaim the property. This is especially true when the market value of the property is substantially less than the balance due on all liens against the property and there is no substantial income from the property.

(I have had my father make a disclaimer related to a trust where he was the sole first tier beneficiary but for very different reasons. We asked an Idaho probate court to allow my father to disclaim one-half of the property which was to pass to my dad on the death of my uncle. In this particular situation by will and trust instrument, the 50% that was disclaimed transferred to the only successor trust beneficiary, my brother, who had no need to disclaim the property which was disclaimed by our father.)

Be careful, however, The basis rules on a nonrecourse mortgage that is secured by real property is derived through a 1983 Supreme Court decision known as Tufts v. Commissioner, 461 U.S. 300 (1983). Without amounts, tax advice is mere speculation. The heir should seek the advice of those who are competent, experienced, and knowledgeable about the income implications of the Tufts Decision, any tax provision limiting or eliminating the misnamed Step Up in basis under IRC Section 1014, and disclaimers. Be careful, however, the step up in basis name is a misnomer. IRC Section 1014 is simply a substitution of the basis of the decedent with the fair market value of the related property as of the date of death of the decedent or alternate valuation allowed under IRC Sections 2032, 2032A, or 2033. So the substituted value can be 1) a step down, 2) a step up, and although rare, 3) no step up or step down.

As is commonly stated in these kinds of situations, it is best to stay in your own lane of expertise when the matter is outside of your area of expertise.

James E. Veale, CPA, MBT May 3, 2021 at 2:28 pm

There is a concept out there about using the proceeds of reverse mortgages to fund the life insurance associated with ILITs, Irrevocable Life Insurance Trusts. The purpose of these transfers to ILITs is to provide the necessary funds to pay for any increased income tax from an actual loss from the step up in basis which has not yet occurred.

While the workings of the ILITs themselves are outside the scope of this comment, it is important to note that specific rules must be followed if the life insurance is to excluded from being included in the estate tax return of the settler of the ILIT. One of these rules require that the payments into the ILIT to buy the life insurance be a taxable gift under the gift tax rules.

What is little known about the Biden/Sanders/Warren-Mann tax proposals is the end of the unified gift and estate tax exemption. Instead the estate tax exemption would go from its present $11.7 million to just $3.5 million and the gift tax exemption to just $1 million. That means that $3 to $4 million of the amount transferred from a taxpayer to an ILIT could end up with a substantial gift tax liability depending on prior gifts subject to the gift tax.

Be careful in the use of reverse mortgages. Even reverse mortgages have limited proceeds available to borrowers. Too many times, borrowers act like those who have just won the lottery. Borrowers should be prudent in how they use these proceeds.


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