Estate Planning

Planning for Special Circumstances

Potential Capital Gains Tax Changes Ahead for Inherited Property

by Rania Combs

Capital gains tax is a type of tax you have to pay when you sell an appreciated asset. You calculate it by subtracting your purchase price (known as the cost basis) from how much you sold it for.

For example, suppose you purchase stock for $10 a share. Your basis is $10 per share, the amount you invested in the stock. Suppose that when you sell the stock, it is worth $100 per share. The difference between the purchase and the sale price is the amount subject to capital gains tax. In our example, $90 per share would be subject to capital gains tax.

Capital Gains Tax on Gifted Property

Receiving a gift is not a taxable event to the one who receives the gift. The gift-giver, or “donor”, is responsible for paying gift taxes if the gift exceeds the annual gift tax exclusion. The annual gift tax exclusion is $15,000 this year.

As the recipient of the gift, you are not required to report any gifts you receive on your income tax return. This is true whether the gift you received is in cash or other property.

However, when you sell the gifted property, taxes become an issue. You are considered to have owned the property for as long as the donor owned it. You also take the donor’s cost basis. When you sell the property, you are required to pay capital gains taxes on the difference between the basis of the appreciated asset and the amount you sold it for.

For example, suppose your mom purchased stock for $10 a share and gave the stock to you during her life. If you sold the stock for $100 per share, you would owe capital gains tax on $90 per share.

Capital Gains Tax on Inherited Property

Property transferred when someone dies receives different capital gains tax treatment.

The beneficiary of inherited property receives a step-up in basis to the date of death value of the property. So if instead of giving you the stock as in the example above,  you inherited the appreciated stock when your mom died, the new basis would be the date of death value. If you sold the stock for the date of death value, you would not owe any capital gains tax.

This rule has allowed wealthy individuals who derive most of their income from investments to transfer stocks, bonds, and real estate investments to their heirs over several generations without income or capital gains tax exposure.

Possible Changes on the Horizon

Congress is considering taxing unrealized capital gains on property transferred at death, on which the original owner never paid income or capital gains taxes. The proposal would allow each individual to exclude $1 million and each couple to exclude $2 million in unrealized capital gains from tax. Gains of up to $250,000 per individual or $500,000 per couple on the sale of a principal residence would also be excluded.

These changes would not affect the estate tax exclusion. The current federal estate tax exclusion is $11.7 million per person and twice that for a couple. The estate tax exclusion amount will be cut in half after 2025 when the current estate tax law sunsets unless new legislation is passed sooner.

Nothing has changed yet, and this proposal may never become law. However,  I will continue to monitor its progress and keep you updated.

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