Gifting Appreciated Securities vs. Waiting for a Step-Up in Basis

The significant appreciation in equity markets has left many investors holding assets with substantial built-in gains. In many cases, tax basis is very low relative to current value. This creates a central tension in estate and tax planning, specifically, whether to recognize capital gains during life or preserve assets for a potential step-up in basis at death.

For many estate plans, the default instinct is to hold appreciated assets until death to secure a basis step-up. That instinct is often correct. However, for individuals facing meaningful estate tax exposure, lifetime gifting of appreciated securities can produce a better overall tax result. This is not a question of right versus wrong but a question of whether the estate tax or capital gains tax has the bigger impact. This analysis generally assumes that the estate exceeds the applicable federal exemption amount and is exposed to estate tax.

The Two Competing Tax Regimes

The two different tax systems that can apply to the same asset are the estate tax and the capital gains tax. The estate tax applies to the value of assets included in the taxable estate at death, while capital gains tax applies when the asset is sold based on the difference between sale price and tax basis.

The federal estate tax is a tax on the transfer of wealth at death that applies to the portion of a decedent’s taxable estate exceeding the available federal estate tax exemption.  The 2026 federal estate tax exemption is $15 million per individual (or $30 million for a married couple using portability), meaning only assets above that threshold are subject to estate tax. Amounts exceeding the exemption are taxed at graduated rates, with a top marginal rate of 40%. As a result, for individuals with estates large enough to incur the tax, a significant portion of wealth transferred at death may be subject to estate tax before assets pass to beneficiaries.

Capital gains tax works differently. It is not imposed merely because an asset appreciates in value. Instead, the tax generally arises when the asset is sold or otherwise disposed of for more than its tax basis. For publicly traded securities held for more than one year, the gain is generally taxed at preferential long-term capital gains rates, with higher-income taxpayers commonly subject to a 20% federal rate. In addition, certain taxpayers may owe the 3.8% net investment income tax on investment income, including capital gains, if their modified adjusted gross income exceeds the applicable threshold. Accordingly, high-income taxpayers may face an effective federal tax rate of roughly 23.8% on long-term capital gains, excluding any state income taxes that may also apply.  These systems frequently pull in opposite directions, creating the need for careful tax and estate planning.

What the Step-Up in Basis Provides

Typically, appreciated securities held until death receive a step-up in basis to the date-of-death fair market value. All prior appreciation is eliminated for income tax purposes, allowing heirs to sell the assets with little or no capital gains tax. However, this benefit comes at the cost of the full value of the asset being included in the taxable estate and may be subject to estate tax. It is also important to note that not all assets receive a step-up in the same manner, with certain items such as retirement accounts subject to different income tax rules.

What Lifetime Gifting Changes

A lifetime gift produces the opposite result. The recipient takes a carryover basis, so the built-in gain remains, but the gifted asset and all future appreciation is removed from the donor’s estate. In effect, gifting sacrifices the step-up but eliminates estate tax on both current value and future growth. The gift does use the donor’s available lifetime estate and gift tax exemption. In other words, using the donor’s remaining exemption may help avoid an estate tax, but will reduce the remaining exemption amount available to shelter transfers from estate taxes at the donor’s passing.

Illustrative Example

Consider an individual with a $100 million estate, including $20 million of highly appreciated securities. If the securities are held until death, the full $20 million is included in the taxable estate, resulting in approximately $8 million of estate tax at a 40% rate, allowing beneficiaries and heirs to receive the step-up and avoid a capital gains tax. If the same securities are gifted during life, the $20 million is removed from the taxable estate, along with all future appreciation, although the gift uses a corresponding portion of the donor’s estate and gift lifetime exemption amount. The recipient takes a carryover basis and may incur capital gains tax when the asset is ultimately sold. Even accounting for that future tax, the overall burden is often lower than the estate tax avoided, resulting in a net tax savings. Lifetime gifting also may provide flexibility because the recipient can control the timing of any future sale, potentially recognizing gain in a lower-income year or using capital losses to offset some or all of the gain.  Alternatively, the recipient may hold the gifted assets until death, at which time the assets would receive a step-up in basis, thus avoiding income tax.

The Key Planning Insight

The question is not whether gifting or the step-up is universally better. The correct strategy depends on the taxpayer’s exposure. If estate tax is not a concern, preserving the step-up is typically advantageous. If the estate tax burden is significant, shifting assets out of the estate may be advantageous. In practical terms, a potential 40% estate tax can outweigh a roughly 20% capital gains tax. Effective planning rarely follows an all-or-nothing approach. Instead, assets are allocated deliberately, with highly appreciating assets often shifted out of the estate, and assets with significant built-in gain retained where the step-up provides the most value. This asset-by-asset, capital gains versus estate tax approach allows both tax systems to be considered together rather than pitted against each other without due care.

Conclusion

The step-up in basis is powerful, but it is not free.  The step-up comes at the cost of estate inclusion. For high-net-worth individuals, that cost can be substantial. Where estate tax exposure is meaningful, lifetime gifting of appreciated securities can reduce total tax liability and increase the wealth ultimately transferred to beneficiaries. The critical issue is not selecting one rule instead of the other, but knowing when each rule applies based on the facts and circumstances.  As a practical matter, this analysis should be revisited periodically, as asset values, exemption levels, and tax laws continue to evolve.