In Tuesday night’s State of the Union Address, President Obama hinted at several changes in capital gains tax treatment, which proposals include eliminating the step-up in basis, requiring estates to pay capital gains on inherited appreciated assets, and raising capital gains tax rates. While the majority of Americans don’t see much income from capital gains, the wealthiest one percent may see about one-third of their income taxed as capital gains. (These are also the individuals most likely to face estate tax problems, with a current federal estate tax exemption amount of $5,430,000 per individual.)

The step-up in basis is a concept that comes in to play when someone dies owning appreciated assets. Generally, if I sell an appreciated asset today, the taxable capital gain is the difference between what I’m selling it for (present value) and its value when I acquired it (its “basis”). But if I die owning that same property, the basis for whoever inherits it is the value upon my death – thus, if the asset has appreciated, my heirs/beneficiaries get the “step-up” in basis. 

The outcome? A tax break, so to speak, for inherited appreciated assets such as real estate and securities. The President’s proposal would eliminate this break, and would also potentially make the owner’s death a taxable event unless the assets were left to a spouse or charity. Perhaps this increase would be in exchange for a repeal of the federal estate tax, as some pundits have suggested? Regardless, it will be very interesting to see how this all plays out! 

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