Biden’s bid to overhaul taxes on inheritances could bring new problems

The wealthy may have an entirely different reason to fear President Joe Biden’s proposal to amend the inheritance tax: They may have to dig through decades of documents to find the what they owe Uncle Sam.

To help fund his American Family Plan, Biden is proposing higher taxes on capital gains and income for the wealthiest families.

He also called for the removal of a decades-old loophole that allowed individuals to inherit assets appreciated at market value without paying taxes on unrealized gains. This tactic is called “stepping to the base upon death.”

Biden proposes ending this “baseline step” for profits in excess of $1 million for single taxpayers – $2.5 million for couples – and ensuring that the amount of the profits will be taxed if the property is not donated to charity.

Coupled with an effort to raise the long-term capital gains rate to 39.6% from 20% for households earning more than $1 million, wealthy heirs could face a pile of taxes.

But determining Uncle Sam’s cut can be difficult for certain properties. That’s because the basis – or the owner’s initial investment in the property – can be difficult to track.

“How do you estimate the basis, especially when the person with the best chance of answering that is dead?” asked Ed Zollars, CPA and partner at Thomas, Zollars & Lynch in Phoenix.

The basis is important because the amount you will pay taxes on when you sell the property is based on the difference between the purchase price and the market value.

If there is no “base raised step upon death”, the heirs will receive the property with the decedent’s base. This also means that heirs could face a large tax bill on profits that have accumulated over decades.

This can pose a conundrum for complex assets, including real estate and small businesses, which rely on year-to-date documents to determine the basis.

Owners of circulating entities – such as limited liability companies – may experience a reduction in basis when they receive distribution from their business. Meanwhile, investment capital into enterprises increased substantially.

“In theory, for an entity that’s been in business for 45 years, I should have gone through 45 years of tax returns,” said KPMG Private Enterprise’s national tax leader, Brad Sprong. “Many times records are not available and it is difficult to obtain transcripts from the IRS.”

Real estate is another complication. Owners can defer capital gains on real estate by swapping one investment property for another in a 1031 exchange.

Investors who operate these exchanges for years and fail to keep proper records run the risk of losing their base over time, which can lead to complications as they sell assets and attempt to identify capital gains tax invoice.

Zollars once had a client selling properties bought in the 1970s and went through multiple 1031 exchanges. “They don’t keep real records,” he said. “It’s manual research, go to the county assessor’s office to find some sales records, preferably indirect.”

Even the track record for longstanding publicly traded assets can become complex.

Custodians, mutual funds, and brokers are only required to comply with federal facility tracking rules beginning in 2011. Investors with shares prior to that period may have problems keeping up. track the basis if they switch brokerage firms or if they are on a dividend reinvestment plan.

“Where things get complicated is when you always have to reinvest,” says Pimco senior advisor for education, Tim Steffen. “Sometimes people forget they’re doing it. They forget they have all those extra facilities and finding the records to report it can be a challenge.”

If you cannot determine the basis – and therefore the extent of the taxes payable – it is considered zero.

Under Biden’s proposal, that would mean heirs would be taxable on the full value of the estate, minus the $1 million exclusion for single taxpayers ($2.5 million). for couples).

Right now, when investors track the basis for long-term investments in the event of a sale and they lack the documentation, they can try to come up with an honest estimate to determine the tax rate. Be warned: The IRS may object to your estimates and methodology.

Here are three steps to starting a fight with the tax officer:

Find your facility now and gather any supporting documents. When it comes to real estate and small businesses, valuation documents and paperwork showing real estate reinvestment and improvements can also help you define your base.

Keep undisclosed records, including statements showing when you sold your shares or when you made distributions from your partnerships.

Make grassroots discussion part of your legacy plan. Likewise, as your heirs should know the location to locate your will, they should also have an idea of ​​your base in your estate. Share those documents with them first and save them the extra effort of figuring out what you originally paid for a property.

Still can’t prove the base? Consider making a charitable donation. If legislators were to eliminate the death walk, Steffen said, assets with a hard-to-determine basis could be good candidates for donation.

You may be able to get a tax deduction based on the fair market value of the property if you donate it to a qualifying charity. Think about it, but don’t act right away.

“Wait for details,” Zollars said. “Any proposed bill is just a proposed bill, but it’s not bad if you get each other’s bases.”