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Sep 13, 2021

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Here’s how capital gains tax changes could impact your clients’ estate planning for 2022

Estate planning is often treated as a “set-it-and-forget-it” topic, but it is vital—especially for wealthy clients—to stay on top of changes in law and in assets because failing to account for current tax law can put your heir’s inheritance at risk of significant reduction. Proposed capital gains tax changes will dramatically shift thresholds, making it more vital than ever for financial advisors to help their clients keep estate plans current and comprehensive.

Historically, the step-up basis has been one of the strongest strategies for wealthy individuals to avoid paying capital gains taxes at death, but proposed changes to tax law could eliminate this rule. The step-up basis allows clients to leave large assets—such as stocks, real estate, and other capital assets—to their heirs without having to pay capital gains tax, as the assessed value of the asset is automatically “stepped-up” to the current market value.

Without the step-up basis, heirs may have to pay capital gains tax on the increase in value between the decedent’s purchase and their death—sometimes meaning decades of value appreciation. Here’s how financial advisors can help their clients prepare for this possible change.

What proposed changes to the capital gains tax affect estate planning?

The new tax laws proposed in April 2021 would eliminate the step-up exemption on any inherited asset that has gained more than $1 million in value between purchase and death. In his April 28th, 2021 speech introducing the proposal, President Biden explained, “Ending the practice of ‘stepping up’ the basis for gains in excess of $1 million ($2.5 million per couple) and making sure the gains are taxed if the property is not donated to charity.”

In 2021, the estate and gift tax exemption of $11.7 million ($23.4 million for married couples) will still allow your clients to pass on up to that amount before paying any estate tax, but any assets rising above that threshold are at risk of double taxation (estate tax and capital gains tax) without the step-up exemption. Additionally, there has been a proposed increase to the capital gains tax, from 29% to almost 49% if including top state and federal tax.

‘The new tax laws… would eliminate the step-up exemption on any inherited asset that has gained more than $1 million in value between purchase and death.’

Let’s use a house, for example:

• Under the current rules, if a house is purchased at $1 million and rises in value to $5 million at the time of the owner’s death, the asset basis is “stepped-up” to $5 million upon inheritance, and the heir pays no capital gains tax.

• Under the proposed rule, for the same house, the asset basis remains at $1 million, and the heir is liable for capital gains tax on the $4 million value that the home has appreciated since purchase. In combination with the proposed increase to capital gains tax, this would mean the heir would have to pay about $1.96 million just to keep the house.

Who would see the biggest impact of these changes?

This will have an outsized impact on the estates of the ultra-wealthy, as they are likely to own many assets that will fall into the new category and will likely exceed the estate and gift tax exemption. Previously, the step-up basis was a solid way to avoid capital gains tax on stocks by placing these holdings into a trust fund for an heir, but this strategy wouldn’t work under the new law.

‘Paying a large capital gains tax could force children to sell a family home.’