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Biden’s offer to tax inherited assets could be a documentation nightmare for wealthy heirs

The wealthy may have a whole other reason to dread President Joe Biden’s proposal to revise inheritance taxes: They may have to dig through decades of documents to determine what they owe Uncle Sam.

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

It also calls for closing a decades-old loophole that allows individuals to inherit assets valued at market value without tax on unrealized gain. This tactic is known as “base increase on death”.

Biden proposes to end this “base increase” for earnings above $ 1 million for single taxpayers – $ 2.5 million for couples – and to ensure that the earnings are taxed if the property does not is not donated to charity.

Coupled with an offer to raise long-term capital gains rates to 39.6%, from 20% for households earning over $ 1 million, wealthy heirs could face a bunch of taxes.

But determining Uncle Sam’s cut could be difficult for some assets. This is because the base – or the owner’s initial investment in the asset – might be difficult to follow.

“How do you rate the base, especially when the person who had the best chance to respond has passed away?” Asked Ed Zollars, CPA and partner at Thomas, Zollars & Lynch in Phoenix.

Base at death

The basis is important because the amount you will pay in taxes when selling an asset is based on the difference between the purchase price and the market value.

Without the “increase in the base on death”, the heirs would receive the asset with the base of the deceased. It also means that the heir could face a big tax bill on the earnings accumulated over decades.

This can pose a conundrum for complex assets, including real estate and small businesses, which rely on years of documentation to determine the basis.

Owners of flow-through entities – limited liability companies, for example – are subject to base cuts when they receive distributions from their businesses. Meanwhile, the capital invested in the business increases the base.

“For a flow-through entity that has been around for 45 years, in theory I would have to go through 45 years of tax filing,” said Brad Sprong, national tax manager for KPMG Private Enterprise. “Often the records are not readily available, and it is also difficult to get transcripts from the IRS.”

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

Investors who make these trades over many years and do not keep proper records risk losing track of their base over time, which can lead to complexity when they sell the property and try to figure out the invoice for it. capital gains tax.

Zollars once had a client who sold a property bought in the 1970s and was the subject of multiple 1031 exchanges. “They kept no real records,” he said. “It’s manual research, going to the county assessor’s office to find a record of sales and purchases, which at best would be indirect.”

Even the basis of tracking long-held publicly traded assets can get complicated.

Custodians, mutual funds and brokerage firms were only required to comply with the Federal Base tracking rules as of 2011. Investors with holdings prior to this period may experience problems finding the basis if they changed brokerage firm or if they were in dividend reinvestment plans.

“Where it gets tricky is when you reinvest all the time,” said Tim Steffen, senior education consultant for Pimco Advisors. “Sometimes people forget they’re doing this. They forget they have all that extra base and finding the records to point it out can be a challenge.”

Zero base vs estimated base

If you are unable to determine the basis – and therefore the magnitude of taxes owed – it is deemed to be zero.

According to Biden’s proposal, this would mean that an heir would be subject to taxes on the entire appreciation of the asset, less the $ 1 million exclusion for single taxpayers ($ 2.5 million for couples).

Right now, when investors research the basis for long-term held investments in the event of a sale, and they run out of documents, they can try to make a good faith estimate to determine the tax impact. Be warned: the IRS may dispute your estimates and methodology.

Here are three steps to anticipate a battle with the tax authorities:

Find your base now and gather all the supporting documents. When it comes to real estate and small businesses, appraisal documents and documents that show reinvestment in property and improvements can also help you triangulate your base.

Keep clean records, including statements showing when you sold your holdings or when you received distributions from your partnerships.

Make the basic discussion part of your estate plan. Just as your heirs need to know where to find your will, they also need to have some idea of ​​where you stand. Share these documents with them in advance and save them the extra work of finding out what you initially paid for an asset.

Still can’t justify the base? Think about charitable giving. If lawmakers remove the increase on death, assets whose base is difficult to determine could be good candidates for a donation, Steffen said.

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

“Wait for the details,” Zollars said. “Any bill is just a bill, but it doesn’t hurt to get your bases together.”

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