Most conversations about leaving money to your children start with the estate tax. For almost everyone reading this, that is the wrong place to start.
For 2026, the federal basic exclusion amount is $15 million per person — $30 million for a married couple who handle portability correctly. If your net worth sits comfortably below that, federal estate tax is not your problem. But there is a second tax sitting quietly inside your balance sheet, and it very much is: the capital gains tax your children will pay on the assets you hand them.
Which tax you are solving for changes every decision that follows. And for a large share of business owners, the answer quietly reversed over the past year.
Two ways an asset reaches your children
There are only two. You give it to them while you are alive, or they receive it when you die. The Internal Revenue Code treats those paths very differently, and the difference is basis.
Basis is what you have already been taxed on — roughly what you paid, plus improvements, minus depreciation. Taxable gain is the sale price minus basis. Change the basis and you change the tax, without changing anything about the asset itself.
Give it away during life and Section 1015 applies: your basis carries over to the recipient. Your child steps into your shoes and inherits your gain along with your asset.
Leave it at death and Section 1014 applies: basis resets to fair market value on your date of death. The gain that built up over your lifetime simply disappears for income tax purposes. This is what people mean by the step-up.
One asset, two outcomes
Say you bought stock in 2005 for $200,000. It is worth $1.2 million today. You have a $1 million built-in gain and a daughter you intend to leave it to.
Path one — you gift it now. She takes your $200,000 basis. If she sells, she reports a $1 million long-term gain. At the top federal rate of 20% plus the 3.8% net investment income tax, that is roughly $238,000 to the IRS before any state tax.
Path two — she inherits it. Her basis becomes $1.2 million. She sells the following week for $1.2 million and reports essentially no gain. Federal tax: approximately zero.
Same asset, same daughter, a $238,000 difference produced entirely by timing.
| You gift it now | She inherits it | |
| Her basis | $200,000 (yours carries over) | $1,200,000 (reset at your death) |
| Gain if she sells at $1.2M | $1,000,000 | Approximately $0 |
| Federal tax at 20% + 3.8% NIIT | About $238,000 | About $0 |
| Federal estate tax, estate under $15M | $0 | $0 |
| Governing section | Sec. 1015 | Sec. 1014 |
The part that surprises people is what did not happen. If your estate is under the exclusion amount, path two costs nothing in estate tax either. You did not trade one tax for another. You simply declined to volunteer $238,000.
Why the default flipped
For most of the last two decades, high-net-worth planning was organized around getting assets out of the estate. When the exclusion was $5 million and scheduled to fall further, that urgency was real: every dollar moved out was a dollar shielded from a 40% estate tax, and surrendering the step-up was a reasonable price to pay.
The Working Families Tax Cuts legislation (Public Law 119-21) changed the arithmetic. The basic exclusion amount is $15 million for 2026, indexed for inflation after that, and it is not scheduled to sunset. The cliff that drove a decade of aggressive gifting is gone.
For a family under $30 million, the estate tax that lifetime gifting was designed to avoid no longer applies. What remains is the capital gains tax that lifetime gifting creates. Same strategy, opposite result.
If your gifting plan was built before 2025, it was built for a world that no longer exists. It deserves a fresh look.
When gifting still wins
Not never, and not for everyone. Lifetime gifting is still the right call in several situations.
You are genuinely over the exclusion
Above roughly $30 million as a couple, the estate tax is real and the step-up is the cheaper thing to give up. Freezing today’s value and moving future appreciation to the next generation still works.
The asset is about to appreciate sharply
Pre-IPO shares, a business heading toward a sale, land in front of a rezoning. Move it before the growth happens and you move the growth with it.
Your state has its own estate tax
Roughly a dozen states impose their own estate or inheritance taxes, several at thresholds far below the federal number. Alabama is not currently among them, which is good news for our Thomasville-area clients — but confirm it rather than assuming, and check every state where you own property or maintain residency. Where the property sits can matter as much as where you do.
There is little or no built-in gain
Cash and high-basis assets cost nothing to give away, because there is no step-up to forfeit. If you are going to gift, gift these first.
The reason is not tax at all
Asset protection, bringing a child into the business, funding a grandchild’s education, or simply wanting to watch them use it. Those are good reasons. Just make the decision with the tax cost visible rather than hidden.
The asset-by-asset sort
The useful question is not “should I gift?” It is “which of these, specifically?” Take your balance sheet and put every holding in one of three columns.
- Gift: cash, high-basis securities, assets with minimal appreciation, and — if you are over the exclusion — anything you expect to multiply.
- Hold: low-basis real estate, concentrated low-basis stock, and the operating business you built from nothing. These carry the largest built-in gains, so they have the most to gain from a step-up.
- Sell: anything you were going to liquidate anyway, and every position now worth less than you paid for it.
That last column is where the surprise is.
Section 1014 cuts both ways
The step-up is really a step to fair market value. If an asset is worth less than its basis when you die, the basis steps down — and the loss you were carrying vanishes. Nobody ever deducts it.
Loss positions should be sold during your lifetime, where the loss offsets gains and up to $3,000 of ordinary income a year, with the remainder carrying forward. Holding a loser until death converts a usable deduction into nothing at all.
Gifting a loss asset does not work either. Under the dual-basis rule, for the purpose of calculating a loss the recipient’s basis is the lower of your basis or the fair market value at the time of the gift. The built-in loss does not transfer. Sell it yourself.
For real estate investors, the step-up does something bigger
This is where it gets interesting for anyone who has run a cost segregation study.
Accelerated depreciation reduces your basis. Ordinarily that is a deferral rather than a windfall: when you sell, depreciation recapture comes back at up to 25% on real property and the rest of the gain follows at capital gains rates. You moved the tax; you did not erase it.
Hold the property until death and the step-up wipes out the entire built-in gain, including everything attributable to depreciation you already deducted. The recapture never happens.
Depreciate aggressively now, hold until death, let your heirs take a clean basis — that sequence is one of the most powerful in the code for a real estate owner. It is also completely undone by gifting the property during your lifetime, which carries your depreciated basis straight to your child.
What a trust does, and does not do, to basis
A common misconception: “the assets are in a trust, so they will get a step-up.” Trusts do not determine basis. Estate inclusion does.
A revocable living trust keeps assets inside your taxable estate. Full step-up. This is the ordinary case and it works as expected.
An irrevocable trust designed to remove assets from your estate generally forfeits the step-up. That was the trade: estate exclusion in exchange for carryover basis. If the trust was created when the exclusion was $5 million, the trade may no longer be worth what you paid for it.
Some irrevocable grantor trusts include a power of substitution that lets you swap assets of equal value in and out. Used deliberately, that power can move a low-basis asset back into your estate, where it will step up, and put a high-basis asset into the trust in its place. It is technical, it has to be done properly, and it is exactly the sort of review an existing trust deserves right now.
One guardrail worth knowing: Section 1014(e) blocks the obvious game. If you gift appreciated property to someone who dies within a year and it returns to you, there is no step-up.
The mistake that costs the most
The most common version we see is a parent gifting low-basis stock to an adult child “because she is in a lower bracket.”
Three things usually go wrong. The gain is often large enough to push the child into the 15% or 20% bracket, and frequently into the net investment income tax, anyway. If the child is under 19, or under 24 and a full-time student, the kiddie tax can apply the parents’ rate to the gain regardless of whose name is on the account. And in every version of this, a free step-up was surrendered to chase a rate differential that turned out to be much smaller than advertised.
If the goal is to help a child now, there are cheaper ways to do it than handing over your single most appreciated asset.
Document basis now, while you still can
Whatever you decide, your executor will have to prove basis on everything you kept, and a step-up is only as good as the valuation supporting it. That means keeping:
- Purchase records for real estate, closing statements included
- A running schedule of capital improvements, which increase basis
- Depreciation schedules for every rental and business asset
- Cost basis records for securities held outside a brokerage that tracks them
- Date-of-death appraisals, which establish the new basis and are worth paying for
Reconstructing this after the fact is expensive and sometimes impossible. Building it now costs almost nothing.
Frequently asked questions
Will my children owe income tax on what they inherit?
Not on receipt — an inheritance is not taxable income. Tax arises only when they sell, and it is measured from the stepped-up basis. That is precisely why the step-up matters so much.
Do I have to file a gift tax return?
For 2026, gifts above the $19,000 annual exclusion per recipient generally require Form 709. Filing does not mean you owe tax; it means the excess reduces your $15 million lifetime exclusion.
Do retirement accounts get a step-up?
No. IRAs, 401(k)s and similar accounts receive no basis adjustment, and distributions to your heirs are ordinary income. Retirement accounts need a different strategy entirely.
Is the $15 million exclusion permanent?
It is not scheduled to sunset, which is a meaningful change from prior law. It is still an act of Congress, and Congress can revisit it. Plan for the law as it stands, and revisit the plan periodically.
Does a revocable trust preserve the step-up?
Yes. Assets held in a revocable living trust remain in your taxable estate and receive the adjustment at death.
What about a house we own jointly?
Generally only the deceased owner’s share steps up. In the nine community property states, the entire community interest can receive a new basis at the first spouse’s death under Section 1014(b)(6). Alabama is not a community property state.
Where to start
Take your balance sheet and sort it: gift, hold, sell. That one exercise surfaces most of the value here, and it usually contradicts at least one assumption a family has been operating on for years.
If you have a gifting plan built before 2025, or an irrevocable trust created when the exclusion was far lower, it was designed around different arithmetic. It should be re-examined on purpose rather than left in place by default.
Ready to sort your balance sheet into gift, hold and sell? Book a risk-free case evaluation and we will walk your assets one by one — call (844) 229-8936 or schedule a meeting online.
This article is general information about federal tax rules as of August 2026 and is not advice for any specific situation. Basis, estate and gift rules interact with state law and with your own facts. Talk to a qualified advisor before acting.
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