How to Turn Your Parents' Estate Tax Exemption Into a Capital Gains Miracle

You may be able to eliminate capital gains taxes on highly appreciated assets by leveraging a parent's unused estate tax exemption for a stepped-up tax basis upon their deaths. Here's how.

Jeffrey M. Verdon, Esq.'s avatar
By Reviewed by
Published In Features
Daughter embracing senior parents sitting at table
(Image credit: Getty Images)

Sarah is a successful business owner who invested wisely in real estate decades ago.

Over time, her properties increased dramatically in value, but the properties' tax bases (called "tax basis") are now incredibly low because she had claimed depreciation on the improvements for tax savings.

Now, Sarah faces a challenge: If she sells her properties, she will owe a large capital gains tax based on those low original values, or she must engage in an IRC Section 1031 tax-free exchange.

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Sarah's parents, Helen and James, recently retired and had a modest estate well below the $15 million per person ($30 million per couple) estate tax exemption, which if unused at their death would be wasted.

Sarah wondered whether their unused exemption could help reduce taxes on her own properties someday.

At a meeting with her estate planning attorney, Sarah learned about a special estate planning tool called a testamentary general power of appointment (TGPA). The TGPA is regularly used to help taxpayers grant powers to other beneficiaries without subjecting the underlying property to risks the grantee may be subject to.

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This power means Sarah could give her parents the right to exercise the TGPA through their wills at their deaths, but if the power was not exercised under their wills, the property to which the power relates is undisturbed.

Why would Sarah do this? Because the assets covered by this power would be included in her parents' estate when they die.

Even though Sarah still owns these assets, they get a big tax benefit when Sarah's parents pass because the tax value of those assets is "stepped up" to their current market value.

For Sarah, this is huge. The property she bought for $200,000, which has now appreciated to $2 million, would receive a step-up in tax basis at the death of Sarah's parents, even if the parents didn't exercise this power via their wills.

If her parents didn't have the power over these assets, Sarah's tax basis would remain at what she paid for the property, less depreciation deductions. If Sarah decided to sell the property for $2 million after her parents died, she would legally owe no capital gains tax.

Due to the step-up in basis at the deaths of her parents, if she decides to keep the property, she receives a new tax basis for purposes of depreciation and amortization to be used to offset the rental income she receives.

Thanks to this planning, Sarah has options she otherwise didn't know existed, which optimize her tax savings for the long term.

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What this means for you

If your parents' estate is below the estate tax exemption amount, it might be possible to use their exemption to step up the tax basis of your assets at their deaths.

This strategy can reduce the taxes you pay when you sell or keep valuable investments and real estate.

Working with an estate planning attorney is critical to set this up correctly.

This story is for educational purposes only and is not legal or financial advice. Always consult with a qualified tax specialist or attorney about your situation.

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Disclaimer

This article was written by and presents the views of our contributing adviser, not the Kiplinger editorial staff. You can check adviser records with the SEC or with FINRA.

Jeffrey M. Verdon, Esq.
Jeffrey M. Verdon, Esq.
Lead Asset Protection and Integrated Estate Planning Partner, Verdon Law Group, LLP Falcon Rappaport & Berkman

Jeffrey M. Verdon, Esq., is one of the nation's leading authorities on integrating advanced estate tax planning and risk mitigation strategies for affluent families and successful business owners. With more than 40 years of experience in designing and implementing integrated estate planning and asset protection structures, Mr. Verdon serves his clients in solving their most complex and vexing estate tax, income tax and legacy planning goals and objectives. Over the past four years, he has contributed over 30 articles to Kiplinger's Adviser Intel online platform.