Political junkies are closely watching to see whether Congressional Democrats will jockey enough votes to pass twin bills that are vital to President Biden’s agenda. One is an infrastructure bill that will invest in America’s roads, power supplies, and ports. The second so-called social-infrastructure bill would invest in, among other things, free community college, child care, and expansions to Medicare. Farmers are also nervously watching to see what happens. But unlike politicos, farmers are concerned the latter bill could have huge implications for their taxes, specifically capital gains.
If you need a refresher on capital gains, I wrote this introduction earlier this year.
In a nutshell, the government taxes individuals on any increase in a property’s value when it’s sold. The purchase price is called the “basis.” The amount you sell the property for over a basis are your “capital gains.” That’s the amount taxed. Currently property that’s inherited is treated differently than property that’s sold. When property is inherited, the heirs get a “step up” in basis that is the property’s fair-market value at the time of the decedent’s death.
Here’s a super simple example. A buys a piece of property for $1,000 (basis). Ten years later he sells it for $10,000. A is taxed on the $9,000 (capital gains) increase in value. But if A dies ten years after purchasing the property, and his kids inherit the property, they will get a step-up in basis to $10,000. So when they go to sell the property, their capital gains are only the value over the new $10,000 basis.
As you can imagine, farmers pay attention to these taxes. Farmers usually own a lot of land, or at least more than most people. They tend to hang onto that property for a long time. So the value of that land can increase significantly over their lifetime. And oftentimes, farmers hold that property until they die and leave it to the next generation. Under the current rules, as long as the property is inherited, there’s no capital-gains taxes.
But President Biden’s proposed changes to capital-gains taxes would change that. There’s a couple different options here. First, Congress could simply eliminate the step-up in basis. So heirs that sell property would pay capital gains on the original basis. Congress could also impose a capital-gains tax at death. So the taxes on the property would be due at death on the original basis, even though the property isn’t sold. Finally, the administration is proposing a significant increase in the taxable rate.
Any of those could make it difficult for children who inherit farmland. Without a step-up in basis, the next generation would have to hold onto the property, even if it doesn’t make sense for their operation. Paying capital gains at death could mean children have to sell the farm just to pay the taxes. And an increase in the taxable rate, with proposals as high as almost 40 percent, almost ensures children can’t keep the property.
I realize the goal is to make “the rich” pay their “fair share.” I understand the rationale of having the wealthy pay more in taxes. I know that some of them use loopholes like the step-up in basis to avoid paying taxes. But while we’re going after the rich, let’s make sure we don’t crush the family farms that are the backbone of our rural communities. Let’s not destroy our legacy of passing farms from one generation to another. Our farms can’t be collateral damage.
Unfortunately, how this will end is completely up in the air. (That makes it really hard to plan, by the way.) Right now, the capital-gains changes are out of the bill (I think–the situation is really fluid). But they could come back in the reconciliation package. So we likely won’t know whether these changes are coming until the bills approved by both chambers and land on the president’s desk. There’s a lot at stake. Farmers are paying attention and worried.