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Capital Gains Loophole?

MoneyWise

Christian talk radio with Rob West

May 30, 2022

The capital gains tax has always been controversial. Some want it higher, some want it lower, and some wish it would just go away. When you buy something that appreciates in value, then sell it, that’s a capital gain which is usually subject to taxes. But there’s a loophole. We’ll explain straigh ahead on MoneyWise. First, a definition. What’s a loophole exactly? It’s an escape clause that Congress leaves in the tax code, either intentionally or unintentionally, that gives us a break on taxes. And the loophole we’re talking about here is called a step-up in basis on capital gains taxes. YOUR BASIS Your basis is what you pay for an asset minus any costs you incur to improve it. An example would be adding an addition to a rental home. That cost would be added to your basis when you sell the property, decreasing the amount of gain and the taxes you’d pay. Now, what’s a step-up in basis? or stepped up basis? That’s when the basis of an inherited asset is recalculated higher than the original price when the owner dies. The tax code specifies that the new basis is stepped up to the current market value of the asset. This holds true for stocks, bonds, real estate and other tangible property. The stepped up basis is one of the few breaks you’ll find for capital gains in the tax code, so you always want to make the most of it when you can. Of course, it’s possible that an inherited asset may have declined in value, but that’s rarely the case. You don’t have to be rich to benefit from the stepped up basis clause. Anyone who inherits a house from a parent then sells it can take advantage of the stepped up basis. HOW IT WORKS Let’s look at how this works. Let’s say Bob buys a share of stock for $10 and over the years, the share appreciates to $25. If Bob sells it, he’ll pay capital gains tax on $15. That’s based on the selling price of the stock, $25, minus his basis (what he paid for it), $10, for a taxable gain of $15. But now let’s say that Bob doesn’t sell. He holds on to the stock until he passes away, at which point the value is, again, $25. In his will, Bob left the stock to his niece, Susie, and she inherits it at the current market value of $25. If she then sells it, does she owe capital gains on the $15 the stock appreciated, like Bob would have? No. That’s because the basis resets at the time of Bob’s death to the current value of $25. If Susie then sells it, her gain is zero and so is her tax liability. The IRS gets nothing from the sale, and that is a rare thing. Now, there are certain provisions that can be good or bad for surviving spouses inheriting property, depending on the state where they live. Residents of nine community property states can take advantage of what’s sometimes called a double step-up in basis rule, but really, it’s just the full basis step up. It means that the full step-up in basis can be used by the surviving spouse on all assets the couple accrued during the marriage, except other inheritances and gifts. In all the other states, the surviving spouse would also get the full stepped up basis if the deceased spouse was the sole owner of the asset, but only half the stepped up basis if the asset was jointly owned. Let’s use another example. John and Mary are a married couple and let’s say they bought a rental home for $100, 000, which appreciated in value to $200, 000 at the time at the time John dies. Since the property was jointly owned, if Mary then sells it, she’d be entitled to just half of the stepped up basis, essentially, John’s half. It would apply to only $100, 000 of the home’s $200, 000 value. So the tax basis for the property would increase to only $150, 000, not $200, 000. Subtract the 150 from the sale price, and Mary will owe capital gains taxes on $50, 000. THE TAKEAWAY Okay, we realize we’ve just given you a lot of provisions and numbers to digest, but the takeaway is that the stepped-up basis is a huge benefit for surviving heirs, and you don’t have to be rich to be blessed by it. Anyone inheriting a an asset (a home, farm, small business, etc. ) and then selling it would face a much bigger tax bill without the stepped-up basis provision. On today’s program, Rob also answers listener questions: ● What are your options to either trade in or refinance a car with a remaining balance? ● How should a young person begin saving for major expenses? ● What are the tax implications of a shared bank account upon the death of one of the account’s co-owners? RESOURCES MENTIONED: ● Ally Bank ● Capitol One 360 Checking ● Marcus

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