April 21, 2021
Tax Treatment of Capital Gains at Death
When an asset is sold that has appreciated in value, such as
subject to the estate tax—a decline of nearly 60% since
a share of stock, the gain is taxed at rates of 0%, 15%, or
2010.
20%, with the top rate applying in 2021 when incomes
exceed $501,600 for a joint return and $445,850 for a single
Potential Revisions in the Tax
return. These income levels are adjusted for inflation. The
Treatment of Capital Gains at Death
rates apply to an asset held for at least one year (referred to
Two proposals have been made for changing the tax
as long-term capital gains); otherwise, gains are subject to
treatment of capital gains at death: adopting carryover basis
ordinary rates (the top rate is 37%). An additional 3.8% tax
and taxing capital gains at death.
applies to capital gains (as well as other passive income)
when incomes reach $250,000 for a joint return and
Carryover Basis
$200,000 for a single return.
Under carryover basis, an asset inherited at death would
retain the basis in the hands of the decedent. In this case,
Capital gain subject to tax is the difference between the
the gain would not escape taxation but would be subject to
sales price and the basis of the asset. For most assets (such
tax when and if the heir sold the asset.
as stocks), the basis is the price paid for the asset. In the
case of depreciable assets, the basis is lower than the
Carryover basis has been proposed as far back as 1942 and
acquisition cost due to depreciation. The part of the gain
in two instances has been enacted into law. The first
attributable to depreciation taken is taxed at ordinary rates.
instance was in 1976, although the law was retroactively
See CRS Report 96-769, Capital Gains Taxes: An
repealed in 1980 and never took effect. The second instance
Overview, by Jane G. Gravelle for further discussion.
was in 2010. In the Economic Growth and Tax Relief
Reconciliation Act of 2001 (P.L. 107-16), the estate tax was
Currently, the capital gains tax is not levied on assets held
scheduled to be reduced and eliminated entirely in 2010 to
until death. These assets are included in the estate at market
be replaced by carryover basis. Although the estate tax was
value and subject to estate taxes of 35% after a significant
restored, executors in that year could elect to pay the estate
exemption (by historical standards) of $11.7 million, as
tax or choose carryover basis, with a $1.3 million
well as other exclusions. (The exemption was doubled in
exemption. Estimates from researchers at the Department of
2017 legislation, P.L. 115-97, and that increase will expire
the Treasury indicated that 60% of estates opted for the
after 2025 unless the law is changed.) The basis for these
carryover basis.
assets is the market value at death, referred to as a step-up
in basis. See CRS Report R42959, Recent Changes in the
In December 2019, Senators Romney and Bennet proposed
Estate and Gift Tax Provisions, by Jane G. Gravelle for
carryover basis with an exemption of $1.6 million for
further discussion of the estate tax.
singles and $3.7 million for married couples, although this
plan was never introduced as legislation.
Proposals have been made to change step-up basis,
including a proposal by then-presidential candidate Joe
The revenue gain from a carryover basis regime would rise
Biden to raise the rate on long-term capital gains and to
over time as heirs sell assets. In its 2020 Budget Options
change the tax treatment of capital gains at death, without
report, the Congressional Budget Office estimated that
specific details.
adopting carryover basis beginning in 2021 would raise
revenue by $110 billion from FY2021 to FY2030, rising
Current Law for Assets Held Until
from $1.2 billion in FY2021 and $4.8 billion in FY2022
Death: Step-Up Basis
(the first full year) to $18.4 billion in FY2030.
Under current rules, when an asset is transferred at death,
the basis is stepped up to the market value at the time of
Taxation of Capital Gains at Death
death. If the heir sells the asset, the gain subject to tax
Another alternative for the treatment of capital gains at
would be the appreciation that occurred since inheriting the
death is to treat death as a realization event (that is, treated
asset. Thus, the gain of the asset in the hands of the
as if the decedent had sold the asset in the last year of life)
decedent would never be subject to income taxes . (Assets
and tax capital gains at that time. The heirs would increase
transferred by gift retain the original basis of the donor.)
the basis by the gains (i.e., their basis would be market
value at time of death, the same as under present law). The
Because of this step-up rule, one justification for the estate
estate value would be reduced by the capital gains tax paid.
tax has been as a backstop to the escape from the capital
gains tax, although the estate tax is now subject to a
Proposals to tax capital gains at death date back to President
historically large exclusion and less effective in performing
Kennedy in 1963 and were proposed by the Ford and the
a backstop rule than in the past. In 2019, 6,409 estates were
Obama Administrations.
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Tax Treatment of Capital Gains at Death
Canada has taxed capital gains at death since 1971 but has
raising capital gains tax rates on realized gains, which are a
no national estate tax, while Australia, Ireland, and the
large part of the income of high-income individuals. While
United Kingdom tax capital gains transferred by gift.
there is disagreement about the magnitude of behavioral
responses (see CRS Report R41364, Capital Gains Tax
H.R. 2286 (Pascrell) and a proposal by Senators Van
Options: Behavioral Responses and Revenues, by Jane G.
Hollen, Booker, Sanders, Warren, and Whitehouse (not yet
Gravelle), a significant offset from the revenue gained on a
introduced as legislation) would tax capital gains at death,
static basis is likely when capital gains tax rates are raised,
with an exemption for the first $1 million of gain. Several
particularly if they were to be raised to ordinary rates.
bills in the 116th Congress—H.R. 8322 (Bass), H.R. 3922
(Pressley) and S. 2231 (Booker)—would have taxed capital
For addressing these objectives, taxation at death is a more
gains at death. These bills had a smaller exemption of
effective approach, and the option of carryover basis would
$100,000, with a $1,000,000 exemption for farm property
allow wealthy family dynasties to avoid capital gains
(to be recovered if the farm property were sold within 10
taxation indefinitely.
years).
Arguments against Revision
According to the Joint Committee on Taxation, the
For both approaches, a traditional argument, especially
exclusion of capital gains at death costs $40 billion per
important in retroactively repealing the carryover basis
year, although this amount would be substantially reduced
enacted in 1976, has been the concern about measuring
with a large exemption. A study in 2013 found that an
basis. Generally, the executor of the will, who is
exemption of $1.3 million (indexed) would reduce the yield
responsible for paying the tax, did not actually hold the
by 45%.
assets. Although taxpayers are responsible for keeping track
of basis, they may not have done so if they expected the
Issues in the Tax Treatment of Capital
heirs to benefit from stepped-up basis. One option for this
Gains at Death
issue is to allow a safe harbor basis of a certain percent of
the asset’s market value.
Arguments for Revision
Failure to tax capital gains unless realized allows high
A second criticism, which applies to the option of taxing
income taxpayers to significantly reduce, especially at high
capital gains at death, is liquidity and the potential for
income levels, their effective tax rates. These taxpayers
forced sales of assets, such as family businesses. This issue
have a major portion of their income from capital income,
already exists under the estate tax and is partially addressed
and a significant share is estimated to be from unrealized
by allowing payment of the tax in installments. One
capital gains. The step-up basis is viewed as a main
proposal by Harry Gutman, former chief of staff of the Joint
contributor to that effect.
Committee on Taxation, would apply the tax only to
marketable securities, with family businesses subject to
As noted earlier, the estate tax often has been viewed as a
carryover basis, taxation at the rate applicable to the
backstop for the failure to tax unrealized capital gains and
decedent, and with an interest charge for the deferral of tax.
other types of income that escape income taxes, with the
large current exemptions making it less effective for this
A third criticism is the additional complexity of taxing
purpose.
capital gains at death. This concern could be addressed by
providing an exemption adequate to confine the tax to
A related argument for adopting carryover basis or taxing
wealthy individuals with resources to deal with tax
gains at death is that the current treatment is viewed as a
complexity.
major reason for the lock-in effect; that is, the tendency to
hold on to assets to avoid the capital gains tax. This effect
Jane G. Gravelle, Senior Specialist in Economic Policy
not only leads to distortions in portfolio choice and liquidity
but also limits the potential for increasing revenue yield by
IF11812


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Tax Treatment of Capital Gains at Death


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https://crsreports.congress.gov | IF11812 · VERSION 1 · NEW

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