If this is accurate, it finally explains something I've been asking about for years: The loan is paid back after the step-up in basis. That's the loophole. If the loan was paid back before step-up, the estate would still have to pay capital gains tax.
The step-up in cost basis on death is the original sin that underpins the entire debate over unrealized gains.
It's disheartening to see so much thought and deliberation going into an obviously toxic idea (taxing unrealized gains) when the obvious solution (removing the cost basis step-up when assets change hands) is being ignored.
Inherited wealth is the least earned, so it should be politically palatable to change this. But presumably because such a change would acutely affect the people who make laws in the country specifically, it is never seriously considered.
Maybe there's just no good solution here, but I think the original inspiration for this sort of law was about family homes. It's one thing to inherit stocks and have to sell some of them off, but it's much more complex to try to pass down a property that can't be arbitrarily subdivided. There are various options obviously, but I think enough people had to sell their beloved childhood home because of the tax obligation that came with the inheritance that someone thought there ought to be a law. Maybe your idea plus a carve out for a primary residence could work, but it doesn't seem politically feasible to me.
First of all, the estate/gift tax does not kick in until 13 M$, so that already covers that case.
Second, it is irrelevant. The capital gains tax that would be due on a normal step-up in basis during life is independent of the estate tax.
Assume there was no exemption and you bought stocks 20 years ago for 100 K$ that are now worth 1 M$. If you die, then your estate would need to pay estate taxes on 1 M$.
However, if instead you sold it the day before you died, you would need to pay capital gains on 900 K$. Then you pass away with N $ = (1 M$ - taxes) in cash. Your estate would then additionally need to pay estate tax on N $.
The step-up in basis is the difference between these cases. Your inheritors get your capital gains (step-up in basis) tax-free, but you still need to pay the estate tax.
Family homes rarely exceed $13M but farms and ranches can get up there. Seems like it should be easy to exclude agricultural land, but there's second-order consequences.
If farms and ranches are the best place to hide family wealth, then family wealth will pour into agricultural land. That inflates values and pushes out the actual ranchers and farmers. If farming is just a byproduct of your tax-avoidance strategy then you are unlikely to try too hard at it. We actually need farms, and nobody wants them to become tax-avoidance shells.
Yeah, I was thinking that despite the fact that the ultra wealthy use TFA's loophole, people who don't (i.e. net worth < $300M as the author explains) have a situation where:
A - In a universe with cost basis step-up on death, they die with gains taxed at 0% and then pay 40% estate tax on everything.
B - In a world without cost basis step-up on death, they die with gains taxed at the 20% long term rate and then pay 40% estate tax on what remains.
Thus:
The step-up causes less tax revenue by percentage from the >$300M crowd who use the BBD strategy, but it causes more tax revenue by percentage from the $13M<crowd<$300M who do not use the BBD strategy. The latter pay more tax with option A! 20% on a chunk and 40% on the remaining chunk is less government revenue than just 40% unchunked, especially if the capital gains being realized on death are a majority of the net worth.
I wonder which crowd has more worth-at-death in aggregate (in the absence of BBD and the like -- if estate tax were to be paid by all, no loopholes), given that the less wealthy crowd is a much larger population.
This is just a guess, but I think it might be more about the government not wanting to put valuations on complex assets. Let’s say I own a network of dry cleaners in Los Angeles. It’s a private business with no public business to compare it against. Cash flow is X, but is the business worth 10 million, 20m? How is the government supposed to determine what it’s worth? Now, let’s imagine your business is Koch Industries. We know it’s worth many billions but there’s a VERY broad range of what it might be. Without taking the stock public, its basically impossible even for top investors to value (investment bankers who value businesses for a living get it wrong all the time), let alone the government.
Even public businesses are not trivial to value for very large shareholders who don’t have the ability to easily sell all shares at once without moving the market quite a bit. But in any case, removing this loophole would just encourage the ultra wealthy to put their money into opaque businesses and then try to “value” them as low as possible. So it’s not so easy to fix.
Nah, the original inspiration wasn't about family homes. It was introduced in 1921, 5 years after income taxes became a thing, and was an attempt by Congress to remove a kind of double taxation that could (at that time) happen with estate taxes.
You would pay an estate tax (on the total value of something, regardless of its cost). And then you'd still (when you eventually sold it) owe capital gains tax.
Regardless of whether you think that particular reasoning makes sense, it definitely doesn't make sense if there's no estate tax (which there effectively isn't for most due to the multi-million dollar exclusion) since there's no risk of double taxation.
Step up basis was actually repealed in 1976. But there was immense pushback at the time around record keeping and Congress eventually agreed and retroactively cancelled the new law.
Whether the answer would be different today in this age of computerised record keeping .... ?
Isn‘t this a false dichotomy? Removing the cost basis step-up doesn‘t automatically mean any taxes are due on the inheitance - you could just keep the low cost basis and pay the tax once you actually realize your gains.
What are you talking about? Removing the step up basis doesn’t force anyone to sell anything. It just means when the asset is sold that capital gains are due—just as they would be if the original owner had sold it while alive—instead of disappearing into thin air.
This might be unpopular but I think there are ways that taxing unrealized capital gains could work without being super radical.
1. Allow unrealized losses to be deducted.
2. Once a certain percentage of the gain is taxed, step up the cost basis by the amount of tax paid. That way you avoid double taxation (once under the unrealized value and again when the asset is sold).
3. (optional) Keep the tax rate on unrealized gains low. Even 3% would be significantly higher than what we have today.
Under this logic, it almost seems like a no brainer. People who have a ton of wealth in unrealized gains would pay taxes progressively over time instead of being hit with a massive tax bill when they sell (or potentially no tax bill when they die due to the step up in cost basis). Feel free to poke loopholes in this idea.
This seemed really reasonable to me until I started thinking about how it might work in practice. The sequence of returns can make this proposal ineffective in practice, even if it makes sense on first blush.
By way of explanation: Let's say you're the founder of Pets.com in an alternate universe where unrealized gains have always been taxed (and correspondingly unrealized losses can be deducted). It's 2000, and you've just had an incredible run. You have also paid incredible taxes along the way.
Then your company blows up and goes to zero.
Now you've payed an incredible amount of taxes on your paper gains, and have realized no gains whatsoever. So the entire enterprise only resulted in an enormous real loss to you. Sure you can now carry forward those losses, but so what? You're never going to make up the difference, unless we're also letting your heirs carry forward those losses into the next century or two.
Given the exposure to massive tax bills without any actual profits, who in their right mind would start or invest in a business under that tax code? Who would dare invest a large portion of their personal worth in public equities given the risk that they plummet, as they did in 2022, 2020, 2008, 2001, 2000, 1987, 1962, 1929, 1907, etc.? Who would take a gamble on a big real estate development? And so on.
It seems to me that a tax on unrealized gains massively disincentivizes investment and the creation of anything new, and therefore the only way to tax capital gains that makes sense is if we calculate the tax due based on when chips are taken off the table. Issues like Buy, Borrow, Die are better addressed with other changes to the tax code that undo the weird incentivizes presently in place (e.g. eliminating the step-up basis, possibly at some threshold if the goal is to make the tax code more progressive). Unless, that is, your goal is to actively disincentivize entrepreneurship and investment. Which if it is, I guess fair enough, but then none of us should be surprised to find ourselves with a lower standard of living in a decade as a result.
I think what you do is simply tax stock ownership. Say you own 100 shares of stock. A 2% tax would mean the government would confiscate 2 of your shares, so you then own 98 shares. The government then proceeds to sell their confiscated shares on the open market (not at once, but spread out over the next year) and use the proceeds as tax revenue. You as an investor can maintain your 100 shares of stock by simply buying back the shares on the open market (or not and so pay a smaller capital gains tax than you otherwise would when you sell. This is your cost basis being adjusted). This also doesn't necessarily disincentive investing, as the tax proceeds can be used for funding jobs (ie investment), and owning stocks can still be worthwhile.
That said, I don't see why there's a need for a deduction here. There isn't one for property taxes. Sure there is one when you sell your property at a loss, and that's also already the case when selling stock. Additionally such a tax like this won't ever cause you to lose your entire stock ownership as it's always based on a fraction of your ownership. And, last but not least, you could also impose caps or progressions.
This tacitly assumes a pretty naive model of how these markets work. The dynamics of poor liquidity, dead equity, stock restrictions, intangible asset loss, etc materially change the outcomes you can expect. In many cases it may cost the government more than the revenue generated, and the counter-party as well. This doesn’t work like your retirement account. Similar types of scenarios historically created by civil litigation have had many adverse consequences to business in practice.
And property taxes are deductible in the US. I’m not sure where you got the impression they aren’t.
>This tacitly assumes a pretty naive model of how these markets work. The dynamics of poor liquidity, dead equity, stock restrictions, intangible asset loss, etc materially change the outcomes you can expect. In many cases it may cost the government more than the revenue generated, and the counter-party as well
In all seriousness, that is extremely unlikely to be the case, especially in broad terms. I mean, to purchase public stock at all you already must do so from a licensed broker, who mind you, is already required by law to report the cost basis of shares purchased by investors. To require them to regularly move 2% of shares owned by investors, to the government's ownership, would be rather trivial in cost to do. Hell, it could be completely automated.
And the cost of it doing that would likely be much less than property taxes, which, is a far less liquid asset, and much more costly to assess than equities, but is nonetheless profitable to tax. I mean the SP500 alone has a market cap of ~$47 trillion, which is, surprising almost the same exact value as the entire US real estate market, but much more liquid.
Additionally, whether it is even profitable at all could be besides the intent of the tax here. It doesn't necessarily have to be profitable, from which perspective, poor liquidity and changes in outcomes isn't a problematic at all. It could be even the intent.
> And property taxes are deductible in the US. I’m not sure where you got the impression they aren’t.
Okay fair. I suppose you could do something similar, but also don't see why it's necessary, just because we do so for other taxes.
The vast majority of wealth is not traded on a liquid market like the S&P. Your scheme only works in nice divisible liquid assets.
Otherwise, when do you expect the government to actually realize its gains? If I have a house I intend to live in until I die and the govt take 2% of my stake away each year, when would it be allowed to force a sale to realize it?
Do I just lose my house once it has a majority stake? Does it just wait until I die? If it does, how is this better than an inheritance tax that is significantly easier to implement?
Taxing unrealized capital gains already isn't all that radical -- property tax is effectively a tax on unrealized gains of property value, and essentially every municipality has that tax.
> Taxing unrealized capital gains already isn't all that radical -- property tax is effectively a tax on unrealized gains of property value, and essentially every municipality has that tax.
Property taxes are a use tax (roads, police, fire, schools, etc), apportioned base on property value, it is not a capital gains tax.
Property taxes do not take into account the amount you paid for your house, so they are not a tax on unrealized gains since the gains are not calculated. You could be underwater on your mortgage and you would be taxed just the same.
Nope it is not. Property tax does not take any gains into account - it's tax on full value (with possible exemptions) not gains, you pay the same regardless whether you bought it for $1 or $1M. Except of course in California where they have this weird scheme which led to the fact that my next door neighbor paid less than half of the property tax I did for pretty much identical house (because they bought it in the 80s) - which looks like negative tax on gains.
In addition to what everyone has already said, property taxes paid are also very explicitly deductible from income taxes. They’re more like an indirect transfer from the Federal government to municipalities, and don’t necessarily result in a substantial aggregate increase in tax burdens.
Also, there is a real debate to be had about if housing should be primary considered an investment or a basic need by society. Many argue that the focus on housing as an investment in the US is a primary driver of our housing problems.
Another thing that could be fixed if we wanted to ensure that wealthy people actually pay taxes during their lifetime would be to treat taking out a loan using an asset as collateral as effectively the same thing as selling the asset and buying it back at the same price. They then have to pay capital gains.ize
Taxing unrealized gains in general I think is impractical since many assets simply don't have well-defined valuations, but if you take out, say, a $10 million loan using, say, shares in a privately traded company, then those shares are apparently worth $10 million dollars because the owner and the bank agreed they were.
From what I can tell the idea was to make sure people would have to sell the family farm or house to pay taxes on unrealized gains on inheritance. It makes no sense to apply that to financial assets.
No, but be careful where you draw the line. In particular, don't draw it between "real estate" and "financial assets". Real estate can easily be a financial asset. Instead, the trick is to draw it between "family farm" and "billionaire who bought 100,000 acres of prime farmland".
Seems straight forward enough, put a value cap on it. $10 million? 20 million? Is anyone going to feel bad for the poor soul who can't pay the tax bill on a free 20 million dollar home?
We have a limit on gifts and according to this is 13 million. Just make it that.
What would be the downside here other than extremely wealthy having to pay some taxes upon death?
If that home is over 10, 13 or 20m dollars... you can pay tax on it. If you have siblings, I assume it would be divided between you, so multiply value by siblings.
If you got a home worth that much, you can pay some taxes on it.
1,500 homes sold for over 10m in a year. We're talking about the richest of the rich. That's exactly who should be paying some taxes. The people bitching about losing 'their' home this way... are either a) delusional or b) looking for a way to protect their incredible wealth.
Is your family home worth more than 10 or 20m dollars?
I can pay taxes on one dollar. It's the principle.
In my country our threshold is significantly lower by the way - it's around a million, so bog standard houses get hit by it.
I think that inheritance taxes are wholly equivalent to wealth taxes, e.g. "you have a thing, I like that thing, give me that thing", and therefore morally wrong.
I could agree with them on the basis that the money were minimal and solely used for security e.g. police and military, it's an insurance policy against theft, the Government has a monopoly on force and that's better than warlords.
It's not used that way though, so I reject the premise.
Basically, you don't believe in government except to protect you from others who might take, while you have would have to ability to take advantage of others freely. No basic humans should be satisified by the government.
That's exactly what the ultra wealthy seem to generally believe too. Sorry that many of us reject your premise that you should be freely protected to screw over everyone else and think that's a moral decision (it's not, but I won't waste my time).
The greatest privilege I suppose I have is that I am able to consider a bog standard three bedroomed terraced family house as being normal regardless of how much bad Governmental policy has managed to inflate the market value.
There are different things that make house/apartment above normal. One is of course size and age. But other things like location have big influence as well (check apartments in central Manhattan).
Instead of trying to analyze hundreds of different what-makes-house-above-bare-minimum aspects we can simply use the price as a good indicator of the underlying value.
And 1mil house is definitely not bare minimum. It is clearly above average.
I'll hand it to you that a $1mm home is definitely valuable, however in my case, living on an island, it's not like I can trade it for anything much less valuable, so it's pretty much non-fungible if you assume I will move from a home I own to another home I own nearby. Sure, if I sell here and move to North Dakota I'll be a wealthy individual there, but I am not going to be doing that. Also, if I sold this and rented, I would have a payment that's 50-65% of what I have in this mortgage, but then even if I have a large equity gain from selling I still have to assume I'll use that money over time to rent, so I'm even again. Homes here are more of an impediment to financial success than in most places. People move away from Hawaii, where they grew up, because it's so unaffordable for normal folks. I am lucky that I am well-employed when I have a job (not right now) and can afford to pay this huge payment in order to secure my children's future housing. They will certainly be well-off with a paid-off home here, but that's rarer these days with a lot more people with new families renting here. I'm not really sure what your point is about the home value in this situation. On the mainland it's a little different because you can move 60 minutes away from most places and find cheaper housing, even if it isn't your favorite place. Here on the islands, you can't just move to a cheaper place, everything is expensive here unless you want to move into a literal shack.
> I'm not really sure what your point is about the home value in this situation.
Everything started with another account saying "In my country our threshold [for inheritance tax] is significantly lower by the way - it's around a million, so bog standard houses get hit by it."
So my point is that 1mil house is not a "bog standard house", whether we look globally or in the USA-only.
Sure, there are some spots in the world in which the average price of the house is going to be higher. But that's irrelevant. It only means that the location is what making that house exceptional.
I understand your practical considerations/explanations about living in an extremely costly place where everything (housing, food, etc) is expensive. But the decision to stay there is on you. "if I sell here and move to North Dakota I'll be a wealthy individual there, but I am not going to be doing that" - is the crux of the issue.
It hasn't been ignored, it's been talked about since it got instated and it's never gotten the political traction to be repealed - sustainably! If you don't ensure it's dead, you end up with a corporate tax situation where entities defer taxable events until the law changes. At one point, you have to stop trying the same failed political approach (futile attempts to repeal the stepped-up basis) and try something new.
We already tax unrealized gains. The US has property tax. When you buy a house, you pay a tax based on it's worth. We just don't have a tax on legal fictions (paper property like stock). The question is, why not? Why can't we also tax that property?
Do you consider municipal property taxes (which, when the property value has risen since purchase, effectively taxes unrealized capital gains) also to be "obviously toxic"?
Yes. In regions where real estate prices explode many people are forced out of their homes because they cannot pay the increased tax. This specifically hits senior citizens hard. It's not uncommon for a property to increase it's taxes >30% some years in these boom towns. This creates an economic burden on long term residents, that is mostly used to pay for infrastructure that is needed to accommodate newcomers.
It's a pretty common belief. People having to sell/mortgage their family homes in order to pay higher taxes because their neighborhood is being gentrified is a self-feeding process. If they didn't have to pay taxes until they sold, it would seem far more just.
Let's be real. No wealth is 'earned'. It's almost entirely luck and social connections. No different from inheritance.
Besides, inheritance can be hard work, psychologically. Your parents may be in a very different socioeconomic group than you for most of your adult life. Your baseline expectation for a 'normal' lifestyle is somewhat elevated (due to the lifestyle you experienced in your childhood) but, for most of your adult reality, you're broke and you feel guilty knowing that your child (the only one you can afford to have) can't have the same childhood that you had.
You work like crazy just to try to earn a living to get back to 'normal' (what you experienced in your childhood) but, deep down, you know you that your best shot at getting there is inheritance in about 30 years' time when you're at death's door (because, with all the stress you experienced, you know you're not going to live as long as your parents). Your biggest worry is that your government will fall to communism and there will be no inheritance.
Your life was basically ruined since the start of adulthood as soon as you were confronted with the ugly reality that labor of any kind is worthless and capital is everything. A reality that your parents will never have to face.
If the government wants to be perfectly consistent and tax people based on how easy it was for them to earn money, then it should impose wealth tax since the amount of wealth tells you the amount of luck and social connectedness at play... And this will also impact inheritance to some extent, but to a fairer extent.
People can live a long time which can turn relatively modest investments with average returns into significant wealth. 21 to 101 is 80 years and cost dollar averaging kicks in.
Sure you could call a long life and decent job luck, but a lot of people live into their 90’s.
You can do a lot to improve your odds of hitting 90 vs what actuarial tables show. Baseline may only be 15% but a very healthy lifestyle can get close to 50/50 which isn’t some major stroke of luck.
I work too hard and not rich enough to live to 90. I'm quite sure of that. Unfortunately, in my reality, I need to work extremely hard just to make ends meet which isn't enough surplus to offset the health problems I'm creating for myself.
I’m sorry you feel that way. Personally I radically reduced living expenses to get out of that kind of situation, but I understand every situation is different.
This is probably the fairest way to earn big money but it's still not fully earned. The number of spots available in universities to become a doctor are limited based on some arbitrary rules (math and physics test-taking ability?) that have nothing to do with what skills are actually necessary to be a good doctor. There are some significant political shenanigans at play here too.
If the system was fairer and doctors experienced close to 'free market' competition, then I would agree 100%, but it's not the case.
I'm sure it's very difficult but doctors have it really good compared to other professionals who also work late and have to compete on a global marketplace with no professional protections/regulatory constraints.
When I first read about the reset (step-up) in basis after death, I couldn't believe this was the law.
Why should inheriting a property reset the basis?
What a ridiculous notion. Someone's already getting an asset for free (inheriting it), and we're further subsidizing the tax liability on it. Taxes that were due to the government are wiped out.
If an asset was worth $50k in 1950, and is now worth $100k, it would feel really weird when capital gains tax is collected on an asset that actually lost more than 80% of it's value over the years.
First of all, this is a really dumb point. If it is so easy to find good assets, why don't you buy those, take the loan against those like the reddit post suggests, then buy even more assets with those money, take another loan, and just keep doing that to generate infinite amount of money? The only reason stopping you is admitting that every asset carries a risk.
But whether it's on you or not is beyond the point. Being taxed on top of a loss is not a good thing.
Also there are plenty of reasons not to sell a depreciating asset. For example, CEO willing to maintain control over company, or simply not wanting to send bad signals to the public by selling their shares (because that would depreciate the asset even more).
A better argument would be to adjust basis for inflation instead of resetting it.
the real problem here (in my opinion at least) is that “borrow” isn’t a realization of gain on the assets. any time illiquid assets are used as collateral that should trigger a taxable event.
> The loan is paid back after the step-up in basis. That's the loophole.
Presuming you can continue to service your debt payments as interest rates and your income varies over time, and are never subject to a margin call due to a drop in the value of your collateral, something even the most powerful are at risk of: https://www.ft.com/content/cf78d815-7ade-40fc-a68d-ec73accb7...
It’s not really any different than what the average American family does with their home.
Except that's not a loophole since the estate will be taxed at the step-up basis. If you bought $20M in assets 25 years ago that are now worth $200M, the step-up occurs so you don't pay capital gains, but you still pay federal estate taxes which is roughly 40%. He hand waves it by talking about moving the assets to an irrevocable trust, but that action is a taxable event... The post is a LARP from a reddior.
That's what I would assume, but it still seems like loans should be paid back first (which may trigger selling assets which would trigger capital gains tax), then estate tax should be levied on anything left, then step-up in basis. If if works this way, there's no loophole.
