Estate Planning Can Save Your Heirs Thousands in Taxes

When families think about estate planning, the focus often falls on who will inherit what. But just as important is how assets are passed on—especially when investment properties are involved. A key tax rule called the stepped-up basis can make an enormous difference in what heirs ultimately keep.

What Is “Stepped-Up Basis”?

The basis of an asset is essentially its original purchase price, adjusted for improvements and depreciation. For tax purposes, when an asset is sold, the difference between the sale price and its basis is considered a capital gain—and it is taxed accordingly.

Here is where estate planning provides an advantage. Upon death, most inherited assets—including real estate—receive a “stepped-up basis” to the property’s fair market value on the date of death.

Example

• If a parent bought a rental property for $200,000 years ago, and at death it is worth $600,000, the “basis” for the heirs becomes $600,000.

• If the heirs sell it shortly after for $610,000, they only pay capital gains tax on $10,000—not $410,000.

Without the stepped-up basis, heirs could face a much larger tax bill.

Capital Gains Tax and Why Timing Matters

For investment property owners, capital gains taxes can eat up a significant portion of wealth if the property is sold during their lifetime. Estate planning helps minimize that burden:

• Holding until death allows heirs to benefit from the stepped-up basis.

• Planned gifting during lifetime generally transfers the original basis, meaning heirs do not get a step-up and may face higher taxes.

This is why deciding when and how to transfer investment property is a critical estate planning choice. Click here for a comparison chart.

Capital Gains Exemptions

The tax code provides certain exemptions from capital gains taxes, which can further reduce the burden on property owners and heirs.

• Primary Residence Exemption (IRC §121): If the property was the decedent’s primary home, and they lived there for at least two of the last five years, up to $250,000 of gain (or $500,000 for married couples filing jointly) may be excluded when sold during their lifetime. This exemption does not apply to rental or investment properties, but it can be significant for family homes.

• Inherited Property Sales: When heirs sell inherited property, the stepped-up basis often eliminates most of the capital gain. If they sell soon after inheritance, there may be little to no tax owed.

• 1031 Exchange: For investment properties, owners may defer capital gains taxes by using a like-kind exchange (IRC §1031) during their lifetime. However, once property is inherited, heirs typically prefer to sell outright since the stepped-up basis already limits capital gains.

Wills vs. Trusts: How Assets Are Passed

Both wills and trusts can transfer investment properties, but they work differently when it comes to privacy, probate, and efficiency:

• Wills: Assets pass through probate, which can take time and become public record. The stepped-up basis still applies, but delays may complicate management or sale.

• Revocable Living Trusts: Properties placed into a trust avoid probate, allowing for a smoother and often faster transfer to beneficiaries. Heirs still receive the stepped-up basis, but the process is more private and efficient.

Some families also use specialized trusts—like Qualified Personal Residence Trusts (QPRTs) or irrevocable trusts—for advanced planning. These strategies may limit or forfeit the stepped-up basis, so legal advice is essential.

Why This Matters for Your Estate Plan

Investment properties often carry sentimental value and significant financial worth. Without thoughtful planning, heirs could face unnecessary capital gains taxes or delays in managing the property. An estate plan that carefully accounts for the stepped-up basis and available exemptions ensures that more of the property’s value stays in the family.

Key Takeaways

• A stepped-up basis can dramatically reduce capital gains tax for heirs.

• Primary residences may qualify for additional exemptions from capital gains taxes.

• Passing property at death (rather than gifting during life) usually provides better tax advantages.

• Trusts can streamline the transfer process while maintaining tax benefits.

Each situation is unique—consulting with an experienced estate planning attorney ensures the right balance of tax efficiency, control, and legacy preservation. Call us today at 301.892.2713 or click here to schedule a complimentary Discovery Session to discuss how we can give you and your loved ones some peace of mind.

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This article is for educational purposes only and should not be considered legal advice.