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The Perils of No Estate Tax
As everyone knows, nothing is certain but death and taxes.
This year, however, there is a lot of uncertainty
surrounding estate taxes, and a lot of misunderstanding
about how the new rules will affect the average real estate
investor.
In 2001, Congress voted to gradually phase out the federal
estate tax, which had been as high as 55%. The law was
temporary, and although federal estate taxes have been
completely eliminated in 2010, the law has a sunset date of
December 31, 2010. Without further action, the old estate
tax rules will return on January 1, 2011. Although many
people expected Congress to intervene and change the law
this year, so far nothing has happened.
The lack of federal estate tax this year is not necessarily
good news for all people who inherit property. For one
thing, many states still have state estate tax. In
addition, with the repeal of estate tax, there is also a
repeal of a significant benefit for real estate investors –
the step up in basis.
How does the step up in basis work? Typically, when real
estate is sold, the gain is the difference between the price
at which it is sold and its basis, which generally is the
price at which the investor acquired the property. However,
when you inherit assets, they receive a full step up (or
step down) in basis to the fair market value of the asset at
the time of death. If heirs immediately sell an inherited
asset, there is no taxable gain. Unfortunately for real
estate owners, the repeal of the estate tax ended this step
up in basis benefit, which means that this year heirs who
sell newly inherited assets may face a substantial taxable
gain.
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