Under the current law, capital gains are taxed as ordinary income if those gains are realized on property held for less than one year. For long-term capital gains (gains on property held for a year or longer), there is a graduated tax rate (zero percent, 15 percent, and 20 percent), depending upon the taxpayer's income bracket. Taxpayers who earn income from investments may be subject to a 3.8 percent net investment income tax on the lesser of their net investment income, or the amount by which their modified adjusted gross income exceeds $125,000 (married filing separately), $200,000 (single or head of household), and $250,000 (married filing jointly), in addition to the applicable capital gains tax rate.
Current law also allows for a step up in the basis on the appreciated property if held until the owner dies. This provides for inherited property to be sold or liquidated shortly after the death of an individual with little to no capital gains tax on the sale.
Today’s law also allows for like-kind exchanges on the appreciated property such as artwork and rental properties, enabling taxpayers to reinvest the gains earned on the appreciated property into similar types of property without having to pay capital gains taxes when the property is later sold. If an individual makes subsequent like-kind exchanges on the appreciated property until that individual’s death, then the capital gains built up in that property will be erased by the basis step-up rules.
Proposed changes under a Biden presidency would either (1) eliminate the step-up basis rule for inherited property and impose a carryover basis rule for inherited property, or (2) impose recognition of gain on property at the death of the owner. Additionally, the Biden tax plan proposes to eliminate like-kind exchanges and impose a 39.6 percent long-term capital gains tax rate on individuals earning more than $1 million per year. If the law retains the 3.8 percent surtax on net investment income discussed above, the effective federal tax rate on long-term capital gains could reach over 43 percent.
If these capital gains and estate tax changes are implemented, many estates could see significant tax bills at the decedent’s death.