Given the anxiety and madness of 2020, which still continues into 2021, more people may be planning ahead and thinking about their estate. And when it comes to estate planning, the main consideration is—taxes. So under this new president, what kind of changes to tax laws might we see, and how will they potentially affect you? In this post, we will examine one major change that President Biden is considering that could significantly affect your estate planning:

ELIMINATING THE STEP-UP BASIS

One of the most drastic changes to the tax code that President Biden may undertake would be the elimination of the estate tax step-up basis rule. The idea of the basis rule is that when assets are passed on to an heir, their basis for assessing gains taxes is their current value, not the profit the deceased may have made on the asset. This essentially eliminates much of the potential capital gains tax that might be assessed on the deceased’s assets.

One of the largest assets many people might have would be real estate, so let’s take this as an example. Let’s say you own property with a child, and the child will receive your half of the property in your will. How estate taxes work will depend on the kind of tenancy you have. We aren’t using the example of transferring property to a spouse, because there are kinds of tenancy in California that allow married couples to transfer property without entering probate, such as the relatively new form of ownership in California, “community property with right of survivorship” (CPWROS). With this tenancy, the property can bypass probate entirely, and for most married couples, this is probably the most advantageous form of ownership.

However, let’s say you and your child own a property as joint tenants with right of survivorship. For California’s purposes, the property passes instantly upon death, just like with CPWROS above. However, the IRS only recognizes survivorship for married couples. It’s important to note that the IRS will assume that the percentage share of the property belonging to the deceased is equal to the percentage they contributed to the purchase price of the property.

But let’s say that the parent and child each owned 50% of the property. To keep things simple, we are going to gloss over the many complexities of how real estate is assessed, such as the homeowner’s exemption, depreciation, and improvements. We’ll just say that they bought the property for $160,000, but the property is now worth $320,000. So the property has doubled in value, and each owns half, so they have each made a capital gain of $80,000.

However, the stepped up tax basis means that the deceased parent’s share will be valued at $160,000 when transferred to the child. If the child sells the land immediately, the capital gains will be assessed based on a tax basis of $240,000 ($160K + $80K) instead of the original $160,000, for a capital gain of only $80,000 for the whole property. This helps limit the inheritor’s tax liability, although it can still be significant, especially if there is a much larger gap between the original purchase price and the current value.

The proposed purpose of eliminating the step-up basis is to better tax the very wealthy. However, this change could actually do more to limit the inheritance from lower-income property owners who do not have access to sophisticated estate planning: according to a recent New York Times article, on average, black families pass on $38,000 to heirs as opposed to $140,000 for white families. The increased taxes could significantly decrease the amount black communities and lower-income areas are able to pass on to their heirs, actually widening income disparities.

In combination with California’s Proposition 19, passed on November 3, 2020, both federal and state taxes may soon be taking a much greater chunk of your heirs’ inheritance. One way to protect your assets is to set up a trust. By placing your assets in a trust, you can ensure that more of your legacy reaches those it’s intended for: your heirs. There are many other potential strategies for protecting your assets from government overreach, and the ideal strategy can only be assessed and set up by an experienced California real estate attorney: consult the experienced attorneys at Greenacre Law today.

For more on trusts, see “What is a trust?” and “How to set up a living trust in California.”