What’s the Stepped-Up Basis Loophole?

Stepped-up basis is a huge loophole for the super-wealthy that shields trillions of dollars of  investment income from taxation. It makes the increase in value–the “capital gains”–of inherited investments disappear for tax purposes, widening economic inequality and losing hundreds of billions of dollars in tax revenue needed to fund vital public services for working families.

How the Loophole Works

A capital gain is the increase in the value of an investment over its purchase price (also known as its “basis”). When the investment is sold (the gain is “realized”) tax is owed on the gain. But when gains are inherited, the loophole zeroes out the gain for tax purposes. As a result, an investment sale that would create a taxable gain for the original owner is tax-free for the inheritor.

Example: an investor buys 100 shares of stock for $200. Ten years later, the stock is worth $500. If she sells the stock, she would owe tax on the $300 gain ($500 sales price less the $200 basis). If instead she dies, her son inherits the stock and immediately sells it for the same price, he would owe no tax. The reason is that thanks to the stepped-up basis loophole, the son’s basis will have been “stepped up” to $500—the investment’s value at the time of inheritance—so that for tax purposes he experienced no gain ($500 sales price less the new $500 basis).

The Stepped-Up Basis Loophole Overwhelmingly Benefits the Ultra Wealthy

The stepped-up basis loophole is a particular bonanza for the super-rich because they hold the lion’s share of unrealized capital gains. The wealthiest 1% own 44% of all such gains, a staggering $21.2 trillion worth. The 64,000 American households worth $100 million or more, including the nation’s 750 or so billionaires, hold almost one-fifth (18%), or $8.5 trillion. For most families, the bulk of any unrealized gains they own is in their home–its rising value is regularly taxed through state and local property taxes. No such taxes apply to business and financial wealth, which makes up almost all (93%) of the unrealized gains owned by billionaires and centi-millionaires.

The Biden-Harris Administration Would Close This Loophole on Gains Over $10 Million

The Biden-Harris Administration’s  plan would tax gains over $10 million per couple (pp. 80-82) when the gains are received as gifts or inheritances, just as if the underlying asset had been sold. This generous exclusion amount means the new rule would exempt all but the super-wealthy. Gains in family farms and businesses would be exempt as long as the family continued to run the operation.