Ag tax advisors like our own Paul Neiffer have been working overtime to clarify possible changes to tax laws affecting farmers. Most of all they have been focusing in on estate and other wealth taxes. Wealth taxes are not new of course. Property taxes are a familiar form of wealth tax. Increasingly the wide disparity in wealth distribution has economists leaning toward these types of taxes for several financial and political reasons. One possible change is the end of the basis step-up. While not a tax increase per se, it would have that effect by ending a tax break. Let’s make sure we all know what it means.
Since 1913 the government has taxed capital gains as well as income. A capital gain is when a citizen buys an asset – anything from Picasso to a quarter section, and then sells it later. If the sales price is more than the purchase price – called the basis - that gain is taxed as a form of income. Or there could be a loss, of course. There are many aspects to this form of taxation that we will ignore to concentrate on one of the oddest, in my opinion – the basis step-up.
Consider this example: A farmer buys a parcel of land for $100,000 in 2000. Since then, the value of land has increased, and it is now worth $300,000 dollars. If she sells the land, she will pay taxes on the gain in value of $200,000. Unfortunately, the day before the deal closes, she dies. Her heir decides to go ahead with the deal. But upon the farmer’s death the basis magically becomes the current value - $300,000, so the heir will have no capital gains to be taxed.
This is a genuine great deal, but what I have never heard a good explanation is why it exists. Why should assets be revalued at death? What moral or economic good does this accomplish? The only answer I have ever heard that makes sense is that it’s a really good deal for people with capital assets. Remember too this tax only occurs if the asset is sold – if the heir simply takes ownership, there is no capital gains tax. There will be strong arguments about how eliminating this tax break will hurt farms but taking away special benefit can be seen as either harm or the end of an unearned gift. Over the next months there will be vigorous debate about whether to end this tax break, but at some point, we all need to ask, why do we have it in the first place?
