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Since taking office, President Biden has expressed his intention to close the step-up in basis loophole as a means to debt reduction. For some investors, this causes alarm as they were planning to use this loophole to leave investments to their heirs without passing on the tax liability.<\/p>\n
Under current law, investors are generally taxed on their capital gains\u2014but if the loophole\u2019s used, there may never be gains upon which to pay taxes. When a person dies and passes an asset onto an heir, the \u201cbasis\u201d (assumed purchase price) of the asset is \u201cstepped-up\u201d to reflect its current value. When the heir sells the asset, they only pay\u00a0taxes on the capital gains accrued while the asset was in their possession.\u00a0This creates a substantial loophole where step-up in basis rules allow some capital gains to escape taxation altogether.<\/p>\n
There are two main ways to close the step-up in basis loophole: tax capital gains at death\u00a0or replace step-up in basis with a carryover basis. The former would impose capital gains taxes before the basis of an asset is stepped up, while the latter would require the inheritor to pay capital gains taxes based on the original basis of the asset at the time of sale.<\/p>\n
Looking at it from President Biden\u2019s view, addressing step-up in basis would improve fairness between taxpayers in similar situations (\u201chorizontal equity\u201d) while also improving the progressivity of the tax code (\u201cvertical equity\u201d). Reforming step-up in basis, whether by replacing it\u00a0with carryover basis or a tax on capital gains at death, would generate substantial revenue. According to the Congressional Budget Office,\u00a0replacing the step-up in basis with a carryover basis\u00a0would generate $110 billion of revenue over a decade. Reforming\u00a0step-up in basis has support from those on both sides of the aisle and from many tax experts. Doing so would improve fairness, efficiency, and revenue collection, and it should be part of the discussion of paying for reconciliation.<\/p>\n