Could a Federal Tax on Unrealized Capital Gains Be Coming in the Future?

In recent months, lawmakers in Washington have pushed a number of different tax proposals, including a bill to reduce the estate tax and gift tax exemption by nearly 70%. Another tax reform effort could also bring big changes to estate planning.

According to reporting from The Wall Street Journal, the Biden Administration has expressed support for a new capital gains tax proposal that has the potential to “ upend estate planning ” for high net worth people and families.

High asset people and families in our region should be prepared for any potential changes to estate taxes and/or capital gains taxes. In this article, our North Carolina estate planning lawyers discuss the proposal to add a new tax to unrealized capital gains at death.

As explained by the Internal Revenue Service (IRS), the capital gains tax is a tax on the profit made from the sale of certain capital assets. For example, imagine that you owned a rental home in Mecklenburg County. The rental home was purchased for $100,000. Later, it was sold for $200,000. You may owe capital gains tax on the profit.

As a general rule, the federal capital gains tax only applies when profit has been “realized” by the individual or corporation that owns the asset. A gain is “realized” at the moment of sale. Referring back to the previous example of the Mecklenburg County rental home, the property owner has a “realized” gain as soon as that property is sold for a profit.

An unrealized gain is one that exists on paper, but has not yet been “booked” through a sale. For example, if you own securities that have increased dramatically in value, you have an “unrealized” capital gain until you actually sell the stock. As long as you hold on to the asset in question, you will not incur capital gains tax liability.

In April of 2021, the Biden Administration rolled out the American Families Plan (AFP)—it is a comprehensive piece of legislation that contains a number of different spending proposals and tax reforms. Notably, the bill calls for changes to the federal tax code that would result in capital gains tax liability being imposed on unrealized gains over $1 million at the time of a person’s death. To be clear, gains under $1 million would still be exempt.

On current federal law, those types of profits are not currently subject to federal capital gains tax liability. Indeed, a person can use estate planning strategies to bequeath property with a “stepped up” basis to a spouse, child, or other loved one. In effect, this means that an heir has the right to use the current fair market value of property as their tax basis, protecting them from capital gains.

It is too early to know what, if any, changes will be coming to capital gains taxes, estate taxes, or inheritance taxes. Similar to other bills in congress, the American Families Plan must clear many hurdles before becoming law. That being said, as federal law is currently written, the estate tax exemption is set to be cut in half in 2025. Further, policymakers in the District of Columbia are consistently pushing proposals that would increase, not decrease, estate tax liability.

With this in mind, people and families in North Carolina who are concerned about potential estate tax liability or capital gains tax liability should take action now to craft a plan to protect their financial interests. There are estate planning strategies that you and your family can use to minimize tax burden. An experienced North Carolina estate planning lawyer will help you devise the best strategy for your specific circumstances.

At Arnold & Smith, PLLC, our North Carolina estate planning lawyers possess the legal skills and professional expertise that you can trust to guide you through complex financial matters. If you have questions or concerns about the estate taxes or capital gains taxes, we are ready to help. Give us a call now or contact us online for a fully confidential case evaluation. From our legal offices in Charlotte, Monroe, and Mooresville, we provide estate planning services throughout North Carolina.