President Biden’s capital gains tax proposal could be the biggest change to capital gains in nearly a century. His American Families Plan would tax unrealized capital gains at death for unrealized capital gains worth over $1 million ($2 million for married couples).

Capital Gains Explained

A capital gain is the increase in the value of an asset over time. For example, if you invest $100 in a stock and its value increases to $300, you have accrued a capital gain of $200. If you decide to sell that stock, the $200 gain would be “realized”, but as long as you keep the stock, it’s considered “unrealized”.

The Plan

Under current law, assets that pass directly to descendants benefit from a step-up in basis, which means the heir receives the asset valued as of the date of death. If the heir turns around and sells this holding immediately, they typically pay minimal capital gains taxes. Biden’s proposal would do away with the step-up in basis. As such, an asset’s unrealized appreciation would be taxed at transfer, meaning the heir would get hit with a hefty tax upon inheritance.

The total top rate on capital gains is currently 23.8% for most assets, but Biden’s plan would raise it to 40.8%, which is higher than the 40% maximum estate tax. The same tax would be applied to unrealized capital gains at death, with the exemption of the first $1 million ($2 million for married couples) plus $250,000 for a personal residence.

Exceptions and Special Rules

• As pointed out above, the first $1 million of unrealized gains ($2 million for married couples) would be exempt, as would gains on a personal residence of up to $250,000 ($500,000 for a married couple).
• Taxes on assets transferred to a spouse would be deferred until the surviving spouse dies or sells the inherited assets. Assets given to charity would be exempt.
• Personal property like household furnishings and personal effects (not including collectibles) would be exempt.
• Some small business stock could be immune to the tax.
• Taxes would be deferred for most family-owned businesses until the family sells out or no longer controls the business.
• Different rules would be applied to assets held by trusts and partnerships.
• Generally, the tax would pertain to those who die after December 31, 2021.

Advocates vs. Critics

Advocates of the plan to tax capital gains at death claim that it would raise over $40 billion for the US government, but skeptics aren’t convinced. Aside from the fact that capital gains taxes historically have been volatile sources of revenue as they are subject to economic conditions, there likely will be tax-planning methods in place—either currently, such as those that apply to the estate tax (e.g., gifting) or some not yet established—to offset or avoid taxation of gains at death.