Thursday, December 01, 2005

A Thought About Basis Inflation

A thought occurred to me regarding my previous post about the inequity present when the Tax Code doesn't provide for basis adjustment to account for inflation. Long term capital holdings actually do have some protection from over-taxation. And what I would suggest to Panda's dad is that he simply hold on the property until death. It's a rather unpleasant thought, I know, but if the property passes to a devisee or an heir, it will acquire the fair market value at time of transfer. Thus if a decedent (i.e. dead person) has highly appreciated property (either appreciated via actual or inflationary increase in dollar value), all of the appreciation is forgiven.

This may offer a partial explanation for Congress's inaction. Someone holding property for a long enough time that inflation would produce unjust taxation is usually going to be older. The negative implication of tax forgiveness at death as a substitute for an inflation indexed basis provision is increased capital lock-in (i.e. someone holding property will be less willing to part with it than they would under economically neutral conditions). Economic neutrality should be the underlying goal of any tax system (according to some), and the failure to provide inflation adjusted basis is a major violation of that goal.


Blogger scarlet panda said...

The current tax regime favors Fuzzy, who desperately wants the property in question and does NOT want our dad to sell it. I think she wants him to give it to her as a gift, though, rather than getting it through inheritance. Would you like to explain the tax implications of the gift transaction?

1:23 PM  
Blogger Fishfrog said...

I would love to. Fuzzy, you do NOT want to acquire that property via a gift. If you dad gives you that property, his basis in the property will become yours. You will not get the (incredibly) favorable fair market value basis you would get if your dad left the house to you in his will. That means that when you eventually sell the house, you'll be taxed on all of the real and inflationary appreciation of the property. And knowing how much you love that house, you will probably hold on to it for many years. This means even more inflation.

However, if you love the house so much that you plan on keeping it forever, there is no harm in his giving it to you while alive. At your death, whomever you live the house to will get the FMV basis (providing Congress doesn't change the code till then (fat chance)).

So just be patient. Did I miss anything Panda?

3:23 PM  
Blogger scarlet panda said...

Sounds complete to me.

5:06 PM  
Blogger warm fuzzy said...

Wow. Thank you! That was extremely informative.

8:26 AM  

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