A step-up in basis can substantially reduce the capital gains tax your children face when they sell inherited property. It is one of the reasons we look carefully at the tax consequences before a Massachusetts homeowner signs a deed giving the house to the children.
A lifetime gift and an inheritance may eventually put the same property in the same hands, but they can produce very different tax results. The decision deserves more thought than whether adding a name to the deed seems convenient.
What Your Basis Actually Is
Your basis is generally the starting point used to calculate gain when you sell property. For a home you purchased, that usually begins with the purchase price, with adjustments for items such as qualifying capital improvements and, where applicable, depreciation. It isn’t necessarily the original price, the current mortgage balance, or the amount you’ll receive at closing. Keeping records of improvements matters because those expenses may increase your adjusted basis and reduce the gain on a later sale. See the IRS guidance on the basis of assets.
What Happens to Basis at Death
When property qualifies for a basis adjustment at death, the recipient’s basis generally becomes its fair market value on the date of death, subject to exceptions and alternative valuation rules. People commonly call this a step-up because appreciated property receives a higher basis, although property that has declined in value can receive a step-down. The adjustment generally doesn’t require the estate to owe federal estate tax. See the IRS guidance on inherited property.
An Example: Inheriting the House
Suppose your adjusted basis in your house is $200,000, and it is worth $700,000 when your daughter inherits it. If the house qualifies for a full basis adjustment, her starting basis would generally be $700,000. If she then sells it for that amount, there may be little or no capital gain, before considering selling expenses and other adjustments. The appreciation that occurred during your ownership generally won’t become taxable capital gain to her merely because she sells the inherited home.
The Same House, Gifted Instead
Now suppose you give her that same appreciated house during your lifetime. For purposes of calculating gain, she generally takes your adjusted basis, subject to applicable adjustments, rather than receiving a new basis equal to the home’s current value. Using the same figures, a later $700,000 sale could begin with $500,000 of gain before selling expenses, exclusions, or other adjustments. The gift may feel generous and straightforward, but you may also be transferring a substantial future tax burden. See the federal law governing basis in gifted property.
The Home-Sale Exclusion Is a Separate Question
The exclusion for the sale of a principal residence is a separate consideration. Qualifying homeowners may exclude up to $250,000 of gain, or up to $500,000 for certain married couples filing jointly, when the requirements are met. Your child doesn’t automatically qualify for that exclusion just because the property was your home. Their ownership, use, and other circumstances need to be reviewed before anyone assumes the exclusion will absorb the gain. See the IRS guidance on selling a home.
Trusts Do Not Automatically Solve This
Trust planning requires the same attention. Some trusts can preserve a basis adjustment at death, while others do not. The IRS has specifically confirmed that grantor-trust status alone doesn’t produce a basis adjustment for assets in an irrevocable trust that are outside the deceased grantor’s federal gross estate under the circumstances addressed in its ruling. The word “irrevocable” doesn’t answer the tax question; the trust’s provisions and the applicable estate inclusion rules do. See IRS Revenue Ruling 2023-2.
Taxes Are Only One Part of the Decision
Taxes also need to be considered alongside your need for housing, access to money, possible long-term-care costs, and your children’s circumstances. A transfer intended to simplify inheritance can introduce issues involving MassHealth eligibility, a child’s creditors, or disagreements about a future sale. Before changing the deed, we should review the property’s basis and value, your existing estate plan, and what you’re trying to accomplish. That allows us to compare the actual consequences of gifting, retaining ownership, or using an appropriately designed trust.
Thinking about putting a child’s name on the deed?
Book a free 15-minute consult call with our Lead Intake Coordinator, Nicole Ott, or give us a call at 978-657-7437. There is no charge and no pressure. The goal is simply to work out what your family actually needs to do next.
