In his State of the Union address, President Obama will, according to a report in the New York Times, propose what his advisors are calling the “trust-fund loophole”, in order to help finance tax cuts for the middle class.
Very interesting. My practice does not involve “trust fund babies” but rather the same middle-class people the President is seeking to benefit. And it is often middle-class people who are the direct beneficiaries of this “trust-fund loophole”.
Let’s first look at what this “loophole” is and and how it works. Suppose a parent gave an adult child the home which the parent purchased in the 1960s for $10,000. Further suppose that when that parent dies that same house is worth $150,000.
When the adult child sells the parent’s home, she will realize capital gain in the amount of $140,000. This amount is the difference between the price at which she sells it – $150,000 – and the parent’s “tax basis” of $10,000. Because the parent gave the property outright during the parent’s life, the adult child received this “carry-over basis” of $10,000.
Now imagine same parent, adult child and house in a different example. Instead of giving the property to the adult child outright during the parent’s lifetime, the parent instead gives the property to the adult child following the parent’s death through a will, trust, life estate deed or other device through which the parent retained certain rights over the house. In that case, the child would receive a “stepped –up basis”–meaning a cost basis equal to the value of the house at the time of the parent’s death.
So we have a very different result. In this case the child’s gain on the sale of the property would be equal to the $150,000 sales price, minus the $150,000 “stepped-up basis” or zero. Zero as in zero capital gains tax to the adult child. Versus $140,000 in capital gains tax in the “carry-over basis” example.
This is the “trust fund loophole” that President Obama seeks to close. The New York Times story quotes administration officials as stating that the tax “would fall almost entirely on the top 1 percent of taxpayers” and “would apply to capital gains of $200,000 or more per couple”.
We’ll see. In the meantime, it’s interesting to see how the term “loophole” can mean different things to different people.