Tax Basis
What is it?
Since president Biden released his tax plan in April there has been a lot of talk about tax basis. In this industry when people hear the word basis, they normally think what the elevator is paying above or below the futures price for physical grain. In this case we are talking about an entirely different thing.
In the tax world Basis refers to in the simplest terms the original purchase price of an asset. For example, if you bought 10 shares of Microsoft in 1999 for $20 per share, first of all good for you, but more importantly your cost basis would be $20 per share or $200 for the entire lot. For tax purposes this only really matters when the asset is sold, that is when the IRS will come knocking.
History
I will try and make this as brief as possible, because I am sure like myself many of you fell asleep during history class growing up. The long and the short of it is President Bidens proposal is not the first time that an administration has attempted to change the basis and tax laws.
- 1976 Tax Reform Act eliminated the Step-Up in basis, this was repealed and Step-Up in basis was reinstated in 1980*
- Tax Relief Reconciliation Act of 2001; laid out a plan to repeal estate tax and Step-Up in basis only for 2010, like a lot of things it makes sense if you dont think about it. In December of 2010 this was repealed and Step-Up in basis was re-instated**
- This is the most interesting of the three and a quick Google search can show you what a mess this created.
- 2015 President Obama took aim elimination of Step-Up in basis but his proposal never made it off the ground***
How it Works Now
Let us take a look at how the tax plan currently works. For example, lets say Fred has a 160-acre farm that he purchased back in 1980 for $20,000. Fred only has one daughter; her name is Sally. At the time of Freds death, the farm was appraised for $1,600,000. Under the current system if/when Sally went to sell the farm, she could use $1,600,000 as her basisand not $20,000 like Fred would have had to use if he would have sold the farm. Hence saving her $316,000, in capital gains taxes ($1,580,000 x 20%).
So, as you can tell for Sally this is a great deal, because she would be able to effectively avoid paying any capital gains tax on the inherited property if she were to sell it right away. Even if she waited for 5 years and the property further appreciated, the capital gains tax would just be on the amount above $1,600,000.
How it could work
Even though the details of President Bidens plan are still up in the air and chances are better then not it will be changed a couple more times before being signed into law, for the purpose of this article lets assume that Step-Up in basis is completely eliminated.
From the example above, when Fred dies and leaves the 160-acre farm to Sally, Sallys basis would be the same as Freds, $20,000. Meaning that if Sally decided she had no desire to own a farm and would like to sell it she would be subject capital gains tax on the sale price less the purchase price of $20,000.
The current law vs the proposed law could have a major impact on Sallys decision to sell or not to sell. Under the current law, she could sell the property with little to no taxes owed. While the proposed tax plan would make the ears of the IRS agents perk up after the sale.
As we discussed earlier, this is far from a new idea. Many different administrations have attempted to pass the same law wrapped up in a different name. We need to remember that right now this is nothing more then a proposal laid out by the current administration. It is no more then a plan until it is signed into law. When you examine the current landscape, I think it will be a long road to hoe before this will be passed, if ever.
Weather you believe this will go through or not it always is useful to stay informed on what impact a proposal could have on you and your family.
I would like to wrap this up by saying my examination of the current and proposed laws is simply a surface view for a deeper look please consult your attorney or tax professional.
*https://www.aperiogroup.com/blogs/repeal-of-basis-step-up-third-times-the-charm
**https://www.taxpolicycenter.org/briefing-book/what-difference-between-carryover-basis-and-step-basis
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