The 'Step-Up in Basis' Loophole: Why Gifting Property Too Early Can Cost You Millions
Key Takeaways
- What is Cost Basis? The original value of an asset for tax purposes.
- The danger of "Carryover Basis" when gifting during life.
- How "Step-Up" works at death to wipe out Capital Gains Tax.
One of the most common mistakes in estate planning is transferring real estate to children while the parent is still alive. While well-intentioned, this can trigger a massive tax bomb known as "Carryover Basis."
Real-world Scenario
Imagine you bought a rental property 30 years ago for $100,000. Today, it is worth $2,000,000. You have a $1.9 million unrealized capital gain.
The Tax Bill if Gifted
If you gift this property to your child today, they receive your "basis" of $100,000. If they sell it tomorrow for $2M, they owe capital gains tax on the full $1.9M gain. Depending on their state and bracket, that could be $400,000 to $600,000 in taxes gone forever.
The Tax Bill if Inherited (Zero)
If you hold the property until death and pass it through a Will or Living Trust, the property receives a"Step-Up in Basis." The new basis becomes the fair market value at the date of death ($2M). If your child sells it immediately for $2M, the taxable gain is $0.
Strategic Planning
Often, the best strategy is to hold highly appreciated assets until death to capture the step-up, and only gift cash or non-appreciated assets during life. Always consult a tax professional to confirm these rules apply to your specific situation in 2026.