Stepped-Up Tax Basis – (Tax Reduction)

Part 7 of... "6 Tax Breaks Landlords Get that Hurt the Economy and You"

Jun 17, 2021

If a landlord sells a rental house and leaves the money to the landord’s heirs, the landlord would have to pay back all the taxes deferred over all those years, for example, the taxes deferred using the depreciation tax deduction on (imaginary) depreciation. In addition, the landlord would have to pay capital gains tax on the profit, the appreciation in the value of the rental house.

But if the landlord doesn’t sell the house and just leaves the rental house directly to the landlord’s heirs, the heirs never have to pay either tax on any of the houses they inherit from the landlord.

The stepped-up tax basis forgives all the back taxes the owner owes on the house when the owner dies.

This is an enormous advantage for investing, including investing in single-family houses, for those who are willing and able to invest. It’s also another great reason to defer paying taxes as much as possible and for as long as possible.

The future tax reduction is so huge some older landlord owners won’t sell now so in the future their heirs can pocket all the money the landlord owners would have had to pay the government if the landlord owners had sold their rental houses themselves.

Once again, the government is essentially paying landlord owners not to sell which lowers the supply of houses for sale.

When people buy and hold houses for the huge estate tax advantages it lowers supply, increases prices, and distorts the market for single-family houses.

Is that fair?

All

Part 1 – 6 Tax Breaks Landlords Get that Hurt the Economy and You

Part 2 – Depreciation Tax Deduction – (Tax Deferral)

Part 3 – 1031 Exchange – (Tax Deferral)

Part 4 – Mortgage Interest Tax Deduction – (Tax Reduction)

Part 5 – Tax-Free Landlord Profit – (Tax Deferral)

Part 6 – Taxes on Capital Gains are a Lot Lower Than Taxes on Ordinary Income – (Tax Reduction)

Part 7 – Stepped-Up Tax Basis – (Tax Reduction)

Part 8 – 6 Distortions of the Housing Market

Part 9 – 2 Sets of Rules for Single-Family Houses

Part 10 – Fixed Supply of Single-Family Houses

Part 11 - Houses for Homes, Not Tax Shelters

Part 12 - Solutions

Part 13 - Permanently Increase Economic Growth

Part 14 - Life is Crazy Enough

Part 15 - The Hardest Part

Part 16 - Distorted Back to Reality

Part 17 - Stop Distorting the Housing Market

Part 18 - Conclusion

Dan Tutolo

Hi John,

There is a similar problem in California, but it is in regards to the government encouraging everyone, including homeowners not to sell. California homes are assessed at purchase price but the taxable value can only increase at like 1% a year. The result is that over a long period of time, like 30 years, a home's value will be much higher than its assessed value. There are homes in CA right now worth over a million only being taxed at $300K or so.

So rather than downsize into a less spacious and easier to care for condo at $500-$600K, these homeowners are encouraged to stay put and pass the home on to their heirs tax free. Sure, real estate investors are are in the same boat, the longer they hold a property, the lower their taxes will be compared to the home's value over time, unlike the state I live in now, Ohio, which does a major assessment every 6 years and a minor assessment every 3 years based on market value.

This stepped-up tax-basis, in general, thought, applies to all real estate passed on to heirs whether it is an investment or not. Granted, homeowners have the $250K/$500K tax exemption so have more freedom to decide to sell rather than hold on to something to pass on to heirs, but again that is for the average homeowner. Trump, Clinton, Obama, and many other congress critters and rich people are also homeowners and their homes are very expensive. Their gains might far exceed the measly $250/$500K tax exemptions and will also be more inclined to hold on to property to pass on to heirs.

I think this issue is more of an inheritance issue in general rather than something just landlords enjoy. The question is, when a family passes on wealth to the next, how much of that wealth accumulated do you think belongs to the government? If you wanted to argue that at least they should have to recapture depreciation I think you have a solid argument. But if you argue that stepped up tax basis should be removed for landlords, if you fairness is your issue, you need to remove it across the board.

And remember that those landlords all live somewhere, and they don't get to depreciate their primary residences as normal homeowners don't get to do and their primary residences can be passed on tax free to heirs.

Maybe if you put a capital gains exemption on landlords, just like homeowners, say of $250/$500K per sale, that might encourage more landlords to sell. If your goal is to get more homes on to the market, that might be enough to nudge some to sell now that would otherwise hold on until death.

What is your ultimate goal? If we want to make more homes available to homebuyers, we could do one or more of the following:

- Give a 7-day first look period to all homeowners nationwide on all homes on the MLS

- Give landlords a $250/$500K tax exemption on all taxes owed for each sale.

- Allow renters and homeowners to deduct normal living expenses just like a business (this would keep more renters in place and take some pressure off competition for the limited number of homes on the market) and just be fairer overall

- Raise interest rates to slow down the demand of homes

- Give tax incentives to convert vacant commercial buildings into condos

- Give incentives for elderly couples to downsize

Respectfully

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Stepped-Up Tax Basis – (Tax Reduction)

Part 7 of... "6 Tax Breaks Landlords Get that Hurt the Economy and You"

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