September 7, 2021

President Biden hasn’t been able to pass many tax increases. We should all be happy.

One tax benefit that remains (for now) is the continuation of the so-called “step up basis” when inheriting an asset. If repealed, the economic consequences would be disastrous.

The step up in basis resets the cost basis of an asset upon inheritance for the purpose of capital gains. Say someone bought an asset for $100 in 1970. The person died in 2020 with the asset worth $1,000 and left it to an heir. The step up in basis allows the cost basis of the asset to be reset to the value on the date of death – in this case, $1,000.

Thus, if the heir decided to sell the asset immediately, they wouldn’t owe any capital gains taxes. If the step up in basis were repealed, the heir would have to pay taxes on the $900 gain.

Admittedly, the step up in basis is flawed because it allows for tax avoidance. However, eliminating it would amplify other tax code flaws.

For instance, the estate tax often forces heirs to sell inherited assets to pay tax bills they receive when inheriting those assets (it happens a lot with family farms). A wave of such forced selling would be problematic.  

A related issue is documentation. Without records, how can you know the original cost? The step up in basis eliminates that necessity.

Lastly, most of the inheritance gains subject to taxation, particularly on long-held assets, are driven by inflation, not appreciation. In our example, the $900 gain was perhaps $600 of inflation. So, the step up in basis shields people from an inflation tax.

All in all, eliminating the step up in basis would create major hassles and generate a drop in the bucket revenue-wise.

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