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Best asset classes when income tax rates rise?

I recently reviewed Biden's tax plan, and it looks like he wants to implement some sweeping tax increases.  Ordinary income rates will go up, he will eliminate LTCG rates and dividends will be taxed at OI rates (along with other tax increases).   Assuming he wins and moves forward with the increases, what asset classes fair best when rates are increased?  I found a bunch of research on asset class performance when interest rates go up, but I couldn't find research on the tax issue.  Thanks

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@FraggyTex wrote:

I recently reviewed Biden's tax plan, and it looks like he wants to implement some sweeping tax increases.  Ordinary income rates will go up, he will eliminate LTCG rates and dividends will be taxed at OI rates (along with other tax increases).   Assuming he wins and moves forward with the increases, what asset classes fair best when rates are increased?  I found a bunch of research on asset class performance when interest rates go up, but I couldn't find research on the tax issue.  Thanks


And just what taxes would be raised on bottom 98% of taxpayers? From what I read Biden proposals would Raise income tax rates only for taxpayers with taxable income above 400K and Cap gains rate increase would only apply if income was over $1M. Democrats would restore the SALT deduction which would reduce my income taxes because I am not in the top 2%.

Please explain what will drive up interest rates when fed has pledged to keep rates at 0 as long as the economy is depressed? Fed dropped rate to 0 in December 2008 where it remained until Dec  2015 when it was raised to 0.25%. Fed was unsuccessful in raising inflation above 2% from 2012 to 2020.

You need to ask yourself the obvious: why would congress raise taxes on the bottom 98% of taxpayers in a recession when they have less money to spend And what happened the last time tax rates were raised in a recession?

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Last Sunday during a Fox interview Trump said that within 10 days he will sign a Health Care Law replacing Obamacare. Does anybody know anything about the new law? 

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Because the trillions of dollars necessary for the various spending plans for Green Energy, Helping the victims of discrimination and the ever popular infrastructure spending bill, needs to come from more than just the top 1%.

Senior citizens living on dividend income will get squeezed. 

Middle Class who try to save and invest their hard earned money in equities will get squeezed. 

The Rich 1% will move their money into other accounts, or set up a "charitable foundation", contribute $10 million to the foundation, and get a $10 million dollar write off. 

Interest rates on Treasuries will go up via the bidding for the excessive amount of debt the government will be floating to pay for all their programs. 

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Re: Best asset classes when income tax rates rise?

I suspect (hope) that any tax increases will be more “targeted” at people with higher incomes, as mentioned earlier. If it looks like you might be in that “group”, I would look at the following:

1) Muni bonds (funds)

2) stocks held for the long run- greater than 1 year

3) equity funds with lower turnover, especially index funds

However, don’t let the “tax man’s tail wag the dog”, in other words be careful about letting tax implications having a large influence on your investments.

Win
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@astrokng wrote:

Because the trillions of dollars necessary for the various spending plans for Green Energy, Helping the victims of discrimination and the ever popular infrastructure spending bill, needs to come from more than just the top 1%.

Senior citizens living on dividend income will get squeezed. 

Middle Class who try to save and invest their hard earned money in equities will get squeezed. 

The Rich 1% will move their money into other accounts, or set up a "charitable foundation", contribute $10 million to the foundation, and get a $10 million dollar write off. 

Interest rates on Treasuries will go up via the bidding for the excessive amount of debt the government will be floating to pay for all their programs. 


And when was the last time congress raised taxes on the bottom 98% of taxpayers? World War II. Since the last comprehensive overhaul of the tax law in 1986 Congress has passed 24 tax laws. The only 3 changes that raised taxes increased the top tax rates because congress likes getting re-elected .

Secondly why would the Congressional Democrats endanger their chance of reelection In 2022 by raising taxes on the bottom 98% of taxpayers when US treasury can borrow an unlimited amount from the federal reserve to pay for their wish list of programs at less than 1.5%? There will be no bidding up of interest rates for future federal debt because the fed as the lender of last resort can loan an unlimited amount of funds to the US treasury at rates below inflation.

You need to forget everything you learned in eco 101 in the new normal of federal debt.

 

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@FraggyTex wrote:

I recently reviewed Biden's tax plan, and it looks like he wants to implement some sweeping tax increases.  Ordinary income rates will go up, he will eliminate LTCG rates and dividends will be taxed at OI rates (along with other tax increases).   Assuming he wins and moves forward with the increases, what asset classes fair best when rates are increased?  I found a bunch of research on asset class performance when interest rates go up, but I couldn't find research on the tax issue.  Thanks


          I’d wait until that “when” becomes a fact. Biden's election, the makeup of Congress, the pace of economic recovery, any tax changes etc. are all “if’s”. Otherwise Intruder and Win have it pegged.

           Personally I’d like to make 100k and pay 20% effective taxes then make 50k and pay10% effective taxes. That old tail wagging the dog thingee.

 

 

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@Intruder 

I hope you're right. 

I'm sending $6,000 to prepay Federal Tax for my 2020 income. My accountant looked at my six month income and dividend income and came to that estimate. I need to create a foundation and give money to a charity. 

I don't know what the new normal will be. Like I said, I hope you're right. 

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Re: Best asset classes when income tax rates rise?

Thanks, Win.  I appreciate the response to my question.  Munis were the only asset class I could come up with, but I'm curious why you mentioned the second and third asset classes.   If all income (including LTCG) is taxed at OI rates, why does turnover or holding for >1 year help?

 

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One of the biggest mistakes many investors have been doing for decades is taking actions based on predictions.

 

 

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Re: Best asset classes when income tax rates rise?


@CarlosDS wrote:

Last Sunday during a Fox interview Trump said that within 10 days he will sign a Health Care Law replacing Obamacare. Does anybody know anything about the new law? 


this sounds like Nixon’s secret plan during the 1968 campaign to end the Vietnam war.

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@astrokng wrote:

@Intruder 

I hope you're right. 

I'm sending $6,000 to prepay Federal Tax for my 2020 income. My accountant looked at my six month income and dividend income and came to that estimate. I need to create a foundation and give money to a charity. 

I don't know what the new normal will be. Like I said, I hope you're right. 


@astrokng 

Foundations are fine for those with assets above 75 million.  

Donor-Advised Funds work for the rest of us.  And are a lot cheaper to set up and cheaper ongoing too.   

ctyankee

 

 

 

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@FraggyTex wrote:

Thanks, Win.  I appreciate the response to my question.  Munis were the only asset class I could come up with, but I'm curious why you mentioned the second and third asset classes.   If all income (including LTCG) is taxed at OI rates, why does turnover or holding for >1 year help?

 


This is because long term compounded returns taxed once after 15 or 30 years of tax-deferred growth will be much higher than gains realized with taxes paid every year or so.  

Charlie Munger said it much better than me: 

"Another very simple effect I very seldom see discussed either by investment managers or anybody else is the effect of taxes. If you’re going to buy something which compounds for 30 years at 15% per annum and you pay one 35% tax at the very end, the way that works out is that after taxes, you keep 13.3% per annum. In contrast, if you bought the same investment, but had to pay taxes every year of 35% out of the 15% that you earned, then your return would be 15% minus 35% of 15% or only 9.75% per year compounded. So the difference there is over 3.5%. And what 3.5% does to the numbers over long holding periods like 30 years is truly eye-opening. If you sit back for long, long stretches in great companies, you can get a huge edge from nothing but the way that income taxes work."

Of course, if the Dems tax unrealized capital gains yearly, as Dan Clifton of Strategas indicated in his recent Barron's interview there is a lot of interest in doing behind the scenes, all of this becomes moot.

"Anyting being discussed that could become law?

If I had to say, then it would be taxing unrealized capital gains. There’s a lot of work behind the scenes to do that, because it gets you a lot more revenue, and it’s essentially a wealth tax without being a formal wealth tax, which would run into constitutional issues."

 

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@Bizman wrote:

@FraggyTex wrote:

Thanks, Win.  I appreciate the response to my question.  Munis were the only asset class I could come up with, but I'm curious why you mentioned the second and third asset classes.   If all income (including LTCG) is taxed at OI rates, why does turnover or holding for >1 year help?

 


This is because long term compounded returns taxed once after 15 or 30 years of tax-deferred growth will be much higher than gains realized with taxes paid every year or so.  

Charlie Munger said it much better than me: 

"Another very simple effect I very seldom see discussed either by investment managers or anybody else is the effect of taxes. If you’re going to buy something which compounds for 30 years at 15% per annum and you pay one 35% tax at the very end, the way that works out is that after taxes, you keep 13.3% per annum. In contrast, if you bought the same investment, but had to pay taxes every year of 35% out of the 15% that you earned, then your return would be 15% minus 35% of 15% or only 9.75% per year compounded. So the difference there is over 3.5%. And what 3.5% does to the numbers over long holding periods like 30 years is truly eye-opening. If you sit back for long, long stretches in great companies, you can get a huge edge from nothing but the way that income taxes work."

Of course, if the Dems tax unrealized capital gains yearly, as Dan Clifton of Strategas indicated in his recent Barron's interview there is a lot of interest in doing behind the scenes, all of this becomes moot.

"Anyting being discussed that could become law?

If I had to say, then it would be taxing unrealized capital gains. There’s a lot of work behind the scenes to do that, because it gets you a lot more revenue, and it’s essentially a wealth tax without being a formal wealth tax, which would run into constitutional issues."

 


And how are unrealized cap gains going to be calculated? Except for stocks purchased since 2011 most cap gains are unknown because the basis And costs are unknown, e.g,, basis in a home or a business, a coin collection, stocks and other assets passed on at death outside of brokerage accounts. And who is going to do the all the calculating? Congress tried to tax accumulated gains in 1976 when it eliminated stepped up basis of capital assets on estates. 4 years later stepped up basis was retroactively restored back to 1976 because Carry over basis was impossible to calculate. 

How would the IRS know Whether the basis is correct since there would be no records of the cost when IRS doesn’t even know if taxpayers are taking the correct amount of required minimum distributions from Retirement plans and IRAs? I know of 2 cases where a retiree never commenced IRA distributions and IRS never knew it.

And as we all know stocks can go down as well as up. Would taxpayers be allowed to obtain a tax refund if the capital appreciation on a stock holding declines from the previous year?

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Re: Best asset classes when income tax rates rise?

At some point the "what ifs?" get overwhelming. I'm with Steelpony - wait and see.

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And to add why would they go back on their goal of restoring the "middle class" as all politicians talk about. I guess it has to do with us becoming the Proletariat.

Maybe the big Roth conversion this year.


@Intruder wrote:

@FraggyTex wrote:

I recently reviewed Biden's tax plan, and it looks like he wants to implement some sweeping tax increases.  Ordinary income rates will go up, he will eliminate LTCG rates and dividends will be taxed at OI rates (along with other tax increases).   Assuming he wins and moves forward with the increases, what asset classes fair best when rates are increased?  I found a bunch of research on asset class performance when interest rates go up, but I couldn't find research on the tax issue.  Thanks


And just what taxes would be raised on bottom 98% of taxpayers? From what I read Biden proposals would Raise income tax rates only for taxpayers with taxable income above 400K and Cap gains rate increase would only apply if income was over $1M. Democrats would restore the SALT deduction which would reduce my income taxes because I am not in the top 2%.

Please explain what will drive up interest rates when fed has pledged to keep rates at 0 as long as the economy is depressed? Fed dropped rate to 0 in December 2008 where it remained until Dec  2015 when it was raised to 0.25%. Fed was unsuccessful in raising inflation above 2% from 2012 to 2020.

You need to ask yourself the obvious: why would congress raise taxes on the bottom 98% of taxpayers in a recession when they have less money to spend And what happened the last time tax rates were raised in a recession?


 

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@Intruder wrote:

@Bizman wrote:

@FraggyTex wrote:

Thanks, Win.  I appreciate the response to my question.  Munis were the only asset class I could come up with, but I'm curious why you mentioned the second and third asset classes.   If all income (including LTCG) is taxed at OI rates, why does turnover or holding for >1 year help?

 


This is because long term compounded returns taxed once after 15 or 30 years of tax-deferred growth will be much higher than gains realized with taxes paid every year or so.  

Charlie Munger said it much better than me: 

"Another very simple effect I very seldom see discussed either by investment managers or anybody else is the effect of taxes. If you’re going to buy something which compounds for 30 years at 15% per annum and you pay one 35% tax at the very end, the way that works out is that after taxes, you keep 13.3% per annum. In contrast, if you bought the same investment, but had to pay taxes every year of 35% out of the 15% that you earned, then your return would be 15% minus 35% of 15% or only 9.75% per year compounded. So the difference there is over 3.5%. And what 3.5% does to the numbers over long holding periods like 30 years is truly eye-opening. If you sit back for long, long stretches in great companies, you can get a huge edge from nothing but the way that income taxes work."

Of course, if the Dems tax unrealized capital gains yearly, as Dan Clifton of Strategas indicated in his recent Barron's interview there is a lot of interest in doing behind the scenes, all of this becomes moot.

"Anyting being discussed that could become law?

If I had to say, then it would be taxing unrealized capital gains. There’s a lot of work behind the scenes to do that, because it gets you a lot more revenue, and it’s essentially a wealth tax without being a formal wealth tax, which would run into constitutional issues."

 


And how are unrealized cap gains going to be calculated? Except for stocks purchased since 2011 most cap gains are unknown because the basis And costs are unknown, e.g,, basis in a home or a business, a coin collection, stocks and other assets passed on at death outside of brokerage accounts. And who is going to do the all the calculating? Congress tried to tax accumulated gains in 1976 when it eliminated stepped up basis of capital assets on estates. 4 years later stepped up basis was retroactively restored back to 1976 because Carry over basis was impossible to calculate. 

How would the IRS know Whether the basis is correct since there would be no records of the cost when IRS doesn’t even know if taxpayers are taking the correct amount of required minimum distributions from Retirement plans and IRAs? I know of 2 cases where a retiree never commenced IRA distributions and IRS never knew it.

And as we all know stocks can go down as well as up. Would taxpayers be allowed to obtain a tax refund if the capital appreciation on a stock holding declines from the previous year?


@Intruder: I hope your list of practical problems with taxing unrealized cap gains will preclude such an outcome.  But on the other hand, when have practical considerations stopped anti-capitalists from wanting to keep squeezing capitalists when there appears to be more blood to be gotten from the turnip?

The seemingly high likelihood of the Senate going blue looks to be a crucial factor this fall.  Is Biden really going to be able to hold back the radicals of his party in their quest to bring equality by punishing those who have, in their view, profited on the backs of the working poor? 

I hope your more sanguine take is prescient.  I'm 50/50 at best on the prospects for reason to prevail.

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@Intruder wrote:

@Bizman wrote:

@FraggyTex wrote:

Thanks, Win.  I appreciate the response to my question.  Munis were the only asset class I could come up with, but I'm curious why you mentioned the second and third asset classes.   If all income (including LTCG) is taxed at OI rates, why does turnover or holding for >1 year help?

 


This is because long term compounded returns taxed once after 15 or 30 years of tax-deferred growth will be much higher than gains realized with taxes paid every year or so.  

Charlie Munger said it much better than me: 

"Another very simple effect I very seldom see discussed either by investment managers or anybody else is the effect of taxes. If you’re going to buy something which compounds for 30 years at 15% per annum and you pay one 35% tax at the very end, the way that works out is that after taxes, you keep 13.3% per annum. In contrast, if you bought the same investment, but had to pay taxes every year of 35% out of the 15% that you earned, then your return would be 15% minus 35% of 15% or only 9.75% per year compounded. So the difference there is over 3.5%. And what 3.5% does to the numbers over long holding periods like 30 years is truly eye-opening. If you sit back for long, long stretches in great companies, you can get a huge edge from nothing but the way that income taxes work."

Of course, if the Dems tax unrealized capital gains yearly, as Dan Clifton of Strategas indicated in his recent Barron's interview there is a lot of interest in doing behind the scenes, all of this becomes moot.

"Anyting being discussed that could become law?

If I had to say, then it would be taxing unrealized capital gains. There’s a lot of work behind the scenes to do that, because it gets you a lot more revenue, and it’s essentially a wealth tax without being a formal wealth tax, which would run into constitutional issues."

 


And how are unrealized cap gains going to be calculated? Except for stocks purchased since 2011 most cap gains are unknown because the basis And costs are unknown, e.g,, basis in a home or a business, a coin collection, stocks and other assets passed on at death outside of brokerage accounts. And who is going to do the all the calculating? Congress tried to tax accumulated gains in 1976 when it eliminated stepped up basis of capital assets on estates. 4 years later stepped up basis was retroactively restored back to 1976 because Carry over basis was impossible to calculate. 

And as we all know stocks can go down as well as up. Would taxpayers be allowed to obtain a tax refund if the capital appreciation on a stock holding declines from the previous year?


On your main points, we agree.  I also agree with your earlier post that puts this whole thread as 'cart before the horse' stuff.  

Certainly, the IRS is not staffed to pull off many of these possibilities.  As it is now, taxes on large estates can take several/many months to be approved (without additional complications).   

Certainly, asset classes like art, coins, etc. will only be reviewed if the size of the estate deems it worthwhile.  

I think your statement of "Except for stocks purchased since 2011 most cap gains are unknown because the basis and costs are unknown" goes too far.  Major brokerages were providing cost basis information before 2011 (a quick check of Google points to as early as 1992).   The responsibility of knowing the cost basis (and documentation) still falls on the individual.  The brokerage sent individual transaction statements  - if you didn't keep them - that's on you.  

Additionally, inherited stock assets got the step-up value, with the individual stock positions listed on the Federal 706 form.  If you wanted to profess complete ignorance as to the stock basis of individual holdings inherited ... the IRS is willing to assume that the basis was 0.   That generally gets people to at least make best-guess estimates.   And in an audit, the IRS is going to want to know what happened to those inherited assets for large estates.  My folks kept all their transactions in binders.      

Therefore, for the individuals that matter, the basis for the vast majority of stock assets are (largely) known.  If you're a big fish and think that the Feds or the State won't be taking a hard look at possible shenanigans ... you may be wrong.     

Overall, I'm in favor of doing away with the capital gains tax and replace it with the individual's tax rate.  It would significantly add to my costs, but it seems fair to me.  However, I'm completely against a tax on unrealized gains and I'm completely against a wealth tax. 

ctyankee  

 

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Re: Best asset classes when income tax rates rise?

FraggyTex,

By holding "low turnover" funds (index funds or active funds with low turnover), you will have much lower tax drag. Secondly, I suspect if they do raise the capital gains rates, they will go up to maybe 28%, I doubt the Democrats would raise them all the way to the top rates. They may also raise capital gains rates only on "upper income" folks, trying to spare the middle class who tend to have much lower capital gains. I would think that they also would tax positions held for longer terms at lower rates, to encourage "investment" (as opposed to speculation). 

Of course this is really all speculation until we see who wins the presidency and both houses of Congress. I would not make any big changes in your portfolio (yet).

Win
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@ctyankee wrote:

@Intruder wrote:

@Bizman wrote:

@FraggyTex wrote:

Thanks, Win.  I appreciate the response to my question.  Munis were the only asset class I could come up with, but I'm curious why you mentioned the second and third asset classes.   If all income (including LTCG) is taxed at OI rates, why does turnover or holding for >1 year help?

 


This is because long term compounded returns taxed once after 15 or 30 years of tax-deferred growth will be much higher than gains realized with taxes paid every year or so.  

Charlie Munger said it much better than me: 

"Another very simple effect I very seldom see discussed either by investment managers or anybody else is the effect of taxes. If you’re going to buy something which compounds for 30 years at 15% per annum and you pay one 35% tax at the very end, the way that works out is that after taxes, you keep 13.3% per annum. In contrast, if you bought the same investment, but had to pay taxes every year of 35% out of the 15% that you earned, then your return would be 15% minus 35% of 15% or only 9.75% per year compounded. So the difference there is over 3.5%. And what 3.5% does to the numbers over long holding periods like 30 years is truly eye-opening. If you sit back for long, long stretches in great companies, you can get a huge edge from nothing but the way that income taxes work."

Of course, if the Dems tax unrealized capital gains yearly, as Dan Clifton of Strategas indicated in his recent Barron's interview there is a lot of interest in doing behind the scenes, all of this becomes moot.

"Anyting being discussed that could become law?

If I had to say, then it would be taxing unrealized capital gains. There’s a lot of work behind the scenes to do that, because it gets you a lot more revenue, and it’s essentially a wealth tax without being a formal wealth tax, which would run into constitutional issues."

 


And how are unrealized cap gains going to be calculated? Except for stocks purchased since 2011 most cap gains are unknown because the basis And costs are unknown, e.g,, basis in a home or a business, a coin collection, stocks and other assets passed on at death outside of brokerage accounts. And who is going to do the all the calculating? Congress tried to tax accumulated gains in 1976 when it eliminated stepped up basis of capital assets on estates. 4 years later stepped up basis was retroactively restored back to 1976 because Carry over basis was impossible to calculate. 

And as we all know stocks can go down as well as up. Would taxpayers be allowed to obtain a tax refund if the capital appreciation on a stock holding declines from the previous year?


On your main points, we agree.  I also agree with your earlier post that puts this whole thread as 'cart before the horse' stuff.  

Certainly, the IRS is not staffed to pull off many of these possibilities.  As it is now, taxes on large estates can take several/many months to be approved (without additional complications).   

Certainly, asset classes like art, coins, etc. will only be reviewed if the size of the estate deems it worthwhile.  

I think your statement of "Except for stocks purchased since 2011 most cap gains are unknown because the basis and costs are unknown" goes too far.  Major brokerages were providing cost basis information before 2011 (a quick check of Google points to as early as 1992).   The responsibility of knowing the cost basis (and documentation) still falls on the individual.  The brokerage sent individual transaction statements  - if you didn't keep them - that's on you.  

Additionally, inherited stock assets got the step-up value, with the individual stock positions listed on the Federal 706 form.  If you wanted to profess complete ignorance as to the stock basis of individual holdings inherited ... the IRS is willing to assume that the basis was 0.   That generally gets people to at least make best-guess estimates.   And in an audit, the IRS is going to want to know what happened to those inherited assets for large estates.  My folks kept all their transactions in binders.      

Therefore, for the individuals that matter, the basis for the vast majority of stock assets are (largely) known.  If you're a big fish and think that the Feds or the State won't be taking a hard look at possible shenanigans ... you may be wrong.     

Overall, I'm in favor of doing away with the capital gains tax and replace it with the individual's tax rate.  It would significantly add to my costs, but it seems fair to me.  However, I'm completely against a tax on unrealized gains and I'm completely against a wealth tax. 

ctyankee  

 


Most taxpayers don’t keep Investment records beyond the 3-6 year period for IRS tax audits which is why they don’t keep confirmations. And in the days when only taxpayers with a net worth of $11.5 M file estate tax returns There will be few heirs who will receive Step up basis information from a 706.

In All of the brokerage statements I have seen brokerages  automatically use step up basis at death when the securities are retitled in the heirs account. No records are kept of what the cost basis was to the decedent or prior owner. So there can be no tracing back to the cost basis of when the stock shares were purchased by the original purchaser. And there are many assets such as RE parcels, non public securities and interests in businesses that have been Inherited through generations without probate or any tax filing that stated the value of the assets. There are just too many capital assets for which there is no means to discover the purchase price for carry over basis to be basis to determine cap gains tax.

Second reason why Carry over basis will not happen is because it would require that every estate which has capital assets be probated In a state court proceeding To determine COB which will impose court costs, executors fees and appraisal fees on the estate which will not be well received by voters. 

only possible way to have carry over basis is to make it prospective on property acquired after the effective date.

 

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