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Category: Estate Planning
Tags: estateinheritanceplanningpropertytaxes
Entities: capital gains taxesCarltonJakeSarahstep up in basis
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If you are a homeowner and you want to pass your home on to your heirs, then you need to do it the right way. Your heirs could either pay zero dollars in capital gains taxes or hundreds of thousands of dollars when you pass down your home to them.
It all depends on you. So today, I'm going to explain everything that you need to know about
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passing your home down to your children in the most tax advantaged way possible. Without further ado, let's dive in.
All right, guys. Let's talk about the homeowners dilemma.
As many homeowners reach retirement age, they start to
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think about what they are going to do with their homes. And a lot of them want to pass their home on to their children after they die.
Others want to give their homes to other relatives or friends. But homeowners face a major decision when they reach this point.
They can either give their homes to their heirs before they die or they can
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give their homes to their heirs after they die. For a lot of people, the natural instinct is to pass the property off to their heirs before they die.
This seems like a kind of kind gesture, if you will, right? You get to see your heirs enjoy it, and it feels like you're helping them out early.
Many people also
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think that transferring the home before their death will give them greater sense of peace because they know they won't be leaving a complicated property transfer to their heirs after they die. But this choice can lead to big tax problems for your heirs because of an extremely important tax code provision called step
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up in basis. If you do not know what step up in basis is, then pay close attention because this is what could literally make the difference between your heirs paying hundreds of thousands of dollars in taxes or zero dollars in taxes when it comes to the property they will inherit from you.
So what is step up in basis? To understand what step up
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and basis is, you first need to understand what basis is. Basis refers to your cost basis.
Kind of confusing. Follow me here.
The cost basis of a property is what you originally paid for it. So, let's just use an example.
If you bought a home for $100,000 20 years
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ago, your basis is $100,000. Now, when you sell a property, the government taxes you on the profit, which is called a capital gain.
The capital gain is the difference between what you sell the house for and your cost basis. So, if
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you sell the house for $300,000, your capital gain is $300,000 minus the $100,000 cost basis. or this would end up being $200,000 of gain.
You would owe capital gains taxes on the $200,000.
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Now, here's where the step up in basis comes in. When you die and you leave a property to your heirs, the basis of the property gets stepped up.
This is such a weird phenomenon that people throw out in the marketplace. I want you to understand what that means.
What it
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means is the basis where you're at that 100K, it's going to be stepped up to its current market value at the time of your death. This means your heirs don't use your original cost basis of $100,000.
Instead, the basis becomes whatever the
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house is worth when you die. So, if the house is worth $300,000 at your death, their new basis, your heirs, your children, is $300,000.
Carlton, why is this such an interesting phenomenon? If they sell it right away for $300,000, there's no capital gains tax.
Their
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capital gain is zero because you bought it for 100K. Their basis got stepped up to 300K, they're selling it at 300K, they don't experience capital gains on that 200,000.
They literally would not owe any capital gains taxes on the sale. But, and here's the crucial thing, if you give the house to your heirs while
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you're alive, they take on your original basis, which would be the $100,000 in this case. If they sell it later for $300,000, they have a capital gain of $200,000 and they'll owe taxes on that amount.
The federal capital gains taxes
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alone on this gain could be roughly $40,000. That is before you factor in any state capital gains taxes.
This is why passing a home before death can be a massive mistake for some people. It could lead to a much bigger tax bill for
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your heirs than you wanted. Passing a million-dollar home before death versus after death is a great example for us to go over next.
Let's walk through another clear example to show the tax differences between passing a home to your heirs before or after your death. And let's use a more expensive home this
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time. Sarah's a parent and she owns a home that she wants to pass to her son Jake.
She bought the house 30 years ago for $100,000. Today, the house is worth $1 million.
Now, her son Jake plans to sell the house soon after receiving it
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because he doesn't want to live there. Let's compare what happens if Sarah gives Jake the house now before she dies versus if he inherits it after Sarah's death.
We'll assume a capital gains tax rate of 20% for this example. Here's scenario number one.
We give the home to Jake before Sarah dies. Sarah decides to
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give the house to Jake while she's alive. Jake takes on the original basis of $100,000.
Let's say a few months later, Jake sells the house for $1 million. Here's how the taxes would break down.
The sales price would be $1 million. The basis would be 100K.
The capital gain would be 900K because 1
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million minus $100,000 equals $900,000. The capital gains taxes on the 900k gain would be 180,000 at the 20% rate.
So Jake would owe a whopping $180,000 in federal capital gains taxes. He could owe thousands more, by the way, in state
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capital gains taxes. In this circumstance, Sarah accidentally saddled her son with nearly $200,000 in capital gains taxes that could have easily been avoided if she had been more savvy when it came to taxes.
Don't do this to your children. Here's what you should do
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instead. Let's talk about scenario number two.
In scenario two, Jake inherits the home after Sarah dies. Now, let's say Sarah keeps the home until she passes away and Jake inherits it through her will.
At the time of her death, the house is still worth a million dollars because of the step up in basis. Jake's
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new basis will be a million dollars. After inheriting it in this situation, he can sell it for a million dollars and he will experience zero capital gains taxes.
This is because the basis got stepped up to the 1 million when he
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inherited the property and then he sold it for 1 million. This means that his capital gains tax bill for the sale would literally be $0 even though the property experienced $900,000 of gain in appreciation during the
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period that Sarah owned it before she died. Another thing to consider here is that Jake would also not owe any estate taxes on the inherited property.
This is because the value of the property is well beneath the estate tax exemption, which is currently 13.9 million in 2025
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for someone that's single. Now, let's say that Sarah's last gift to her son in this situation was this property.
Sarah cared deeply about her son. Just as I'm sure all of you watching this video care deeply about your children.
Now, instead of forcing him to deal with a massive tax bill on top of the grief of losing
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his mother, she took the time to learn how to optimize his tax savings for property transfers. This gave him almost $200,000 of extra money that he will now get to keep and use to build a better life for himself and his family.
This was Sarah's last gift to her son. And
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believe me, this kind of gift is one that really counts. So, if you have children and if you're thinking about passing on properties to them, I highly recommend that you consider doing it after your death as opposed to before your death or work with an estate planning attorney that's helping you mitigate your estate tax bill to offload
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properties yourself. Carlton, what about rental properties?
Does step up and basis apply to rental properties as well? Yes, step up in basis applies to rental properties in addition to primary residences.
So, you can also save your heirs a fortune in taxes just by passing
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rental properties to them after your death as well. Now, let's go over how to plan wisely.
In most cases, it's going to be significantly more advantageous just to keep the home in your name and let your heirs inherit it after you die. Here are some simple steps to make this work.
Make a will or a trust. A will is
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what a will is, and a revocable living trust ensures your home goes to the right person after you die. A trust can also avoid probate, which is the legal process of distributing your assets.
Now, I want you to talk to a tax professional. Every family's situation is different.
A tax adviser or estate
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planner can confirm if waiting for the step up in basis is best for you. Consider also other assets.
If you want to help your heirs now, consider giving cash or other assets that don't have big tax consequences. And here's my final conclusion.
Passing a home to your heirs
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before you die might seem like the right choice at first, but it can lead to a big tax bill because your heirs miss out on the step up in basis. Most people don't even know about step up in basis.
Plus, keeping the home until you die gives more control and avoids other risks like family disputes. For most
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people, waiting until after death is the smarter way to pass on a home. By planning ahead with a will and a trust and talking to a tax professional, you can make sure your heirs get most of the benefits with the least hassle possible and the least amount of taxes possible.
That's all I've got for today's video, guys. As always, don't forget to like,
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comment, subscribe. We're growing this channel and we're just doing everything we can to give you more information that will help you build a tax-free life.
Thank you so much for tuning in. I'll see you on the next video.