The Angel of Death
A key aspect of generational wealth transfer.
As most of you may know, I have been focusing a lot of my time on the tax planning front. To me, it is one of the simplest ways to add value for a lot of people we work with.
I have been quoting the joke someone made a lot as of late: “You can make someone $100,000 in the market and they’ll never love you as much as the person who saved them $10,000 in taxes.”
Of course, this is a joke. We’d all prefer the $100,000. Yet, it taps right into the psychology of paying taxes. Most people do not enjoy paying taxes and if there are any avenues to reducing a tax bill, they are usually interested in hearing it.
Today’s topic may not seem too applicable to young professionals at face value, but with the anticipated wealth transfer from Boomer’s it is something to note.
The step-up in basis is such a powerful wealth transfer tailwind that some even refer to it as “The Angel of Death.”
Essentially, when taxable assets (real estate, brokerage accounts, most assets that are not held in a tax-advantaged account) are passed onto heirs after someone passes, the basis is stepped up to the fair market value on the date of their death.
There is no way in which my writing could express how significant this is.
Let’s review some of the basics before I show an example. Basis is the price an investor pays for their assets. Think of basis like an anchor. It dictates whether there is a capital gain or loss associated with an asset.
Now, let’s dive into an example of how this step-up in basis can be so powerful.
Assume that Person A bought shares of a company back in the day. They bought $100,000 of this company.
Fast-forward, and we’ll assume that this investment did incredibly well. It is now worth $1,000,000.
If they are to sell the position entirely, the gain of $900,000 could be subject to taxes. This could be a significant drag and quickly erase a great amount of the gain!
For a quick, back of the napkin tax assumption, if the gains were taxed at 20% along with NIIT of 3.8%, this could result in over $200,000 in taxes being owed.
However, if Person A passed this holding to their child, Person B, the basis is entirely reset.
Assuming Person A died and the fair market value was $1,000,000, Person B’s new basis is $1,000,000.
Meaning they can literally turn around and sell the position for $1,000,000 and be subject to no tax.
The step-up in basis is literally one of the most powerful tailwinds in generational transfers of wealth.
While it may not seem like it is applicable today, lots of financial planners are working with older clients to ensure this step-up is used to the fullest extent for the next generation.
This is for informational purposes only and is not intended as legal, tax, or investment advice or a recommendation of any particular security or strategy. The investment strategy and themes discussed herein may be unsuitable for investors depending on their specific investment objectives and financial situation. Opinions expressed in this commentary reflect subjective judgments of the author based on conditions at the time of publication and are subject to change without notice. Past performance is not indicative of future results.