Bizarre Tax Rule Stifles Housing Market, Real Estate Industry

I noticed this tweet from a wealth adviser:

“The greatest perpetuator of U.S. wealth inequality is the stepped-up basis rule. Basically, when you die, all the capital gains on your assets (home, stocks, etc.) are erased. Your heirs get your assets as if they were purchased on the date of your death. Unreal.”

New York City developer Eli Lever then asked, “Is there a reasoning behind this?” A certified financial planner replied dryly: “The reasoning is that wealthy people have an incredibly strong instinct to pass wealth to their heirs, which requires them to remove pesky obstacles like taxes.”

The wealth-equality argument against the stepped-up basis rule is obvious, but there’s a housing market case to be made as well.

The rule provides a strong financial incentive for aging empty-nesters to keep a home that has appreciated greatly in value, even if it is entirely inappropriate for their lifestyle, until death. It might be too large, have high property taxes and lots of stairs, and not be within walking distance of stores, restaurants and relatives.

Until all the owners of such a home die, the home is unavailable to a growing family that needs it. The result is fewer homes on the market, higher prices, fewer commissions for real estate agents and less income for everyone else involved in sales — mortgage brokers, title companies, appraisers, etc.

Dealing with a house after parents die can be a chore and a source of disagreement for heirs. If one sibling wants to sell, another wants to move in and a third wants to make it a rental property, you have a potentially nasty squabble at a difficult time. What agent wants to be in the middle of that?

If you think for all these reasons that the National Association of Realtors would be out lobbying to end the stepped-up basis — something Joe Biden wanted to do as president — you’d be wrong.

In fact, the NAR strongly supports retaining the rule, although in an article announcing that position in November 2023, the organization didn’t bother to explain why. Presumably, it’s because the stepped-up basis makes a home more valuable to its owner as something to bequeath in a will, albeit akin to golden handcuffs. NAR has also noted that inflation represents a large component of home price appreciation.

Tracy Kasper was president of NAR at the time. She resigned two months later during a long period of tumult and controversy for the group, which was facing much more pressing issues than tax policy.

But it would be nice to see real estate trade groups revisit the matter. Ditching the stepped-up basis rule would have benefits for their members, homeowners, their children and the housing market.