Gifting Appreciated Assets vs. the Step-Up in Basis: When a Lifetime Gift Costs More Tax

By Eric Ridley, attorney, Ridley Law. Updated October 2026.

Part of our strategies that backfire series.

Estate size this page covers: every band, for different reasons. Below $15 million for one person or $30 million for a married couple, a gift of a low-basis asset saves no estate tax at all, so the lost step-up is pure cost. From $15 million to $100 million and above, the gift saves estate tax only on growth after the gift, and the math below shows how much growth that takes. For the larger picture see high net worth estate planning in California.

What giving low-basis stock costs compared with holding it

The usual pitch is that the exemption is $15 million per person in 2026 (Rev. Proc. 2025-32), so you should move assets out of your estate now and let the growth go to the children free of estate tax. For cash, that works. For the founder’s stock bought at pennies, the rental building bought in 1990, or the family company, it often costs more than it saves.

Take Martin, who is hypothetical and not a real client. He is a California widower who owns stock worth $10 million with a $1 million basis. He has made no taxable gifts before, so a gift of the stock uses $10 million of his exemption and no gift tax is due. His other assets are large enough that every added dollar in his estate tax calculation is taxed at 40%. The stock grows 50% to $15 million by his death, and his daughter sells it right after. Giving the stock now costs $3,194,000 more in total tax than holding it, and the gift would need about $115 million of growth to break even.

Assumptions: 40% estate tax at the margin (IRC § 2001(c)). Income tax is at the top rates: 20% federal (IRC § 1(h)(1)(D)), 3.8% net investment income tax (IRC § 1411), and 13.3% California, which is the 12.3% top bracket in the FTB’s 2025 rate schedules plus the 1% surcharge on income over $1 million (R&TC § 17043). The model ignores lower brackets, the cap on deducting state tax, and growth on the cash Martin keeps.

Why the gift carries your gain and the step-up erases it

The person who gets your gift takes your basis, so your built-in gain moves to them (IRC § 1015(a)). Had you held the asset until death, its basis would have reset to its value at death and the gain would have disappeared. The Supreme Court upheld the carryover rule in 1929 against the argument that the donee should be taxed only on growth during her own ownership. In Taft v. Bowers (1929) 278 U.S. 470, a father gave his daughter stock worth more than he paid, and she sold it. The Court held Congress could tax her on the whole gain from his cost, reasoning that she “voluntarily assumed the position of her donor.”

Property acquired from a decedent takes a basis equal to its fair market value at the date of death (IRC § 1014(a)(1)). That reset is what people mean by the step-up. See stepped-up basis in a California trust. It applies to property that passes by will, through a revocable trust, or otherwise from the decedent as § 1014(b) lists.

An asset worth less than you paid loses its loss in a gift

If your basis is higher than the asset’s value on the day of the gift, the donee’s basis for figuring a loss is that lower value (IRC § 1015(a)). The loss you could have taken disappears. Holding the asset until death doesn’t save it either, because § 1014 resets the basis down to value. An asset worth less than you paid is one to sell yourself, take the loss, and give the cash.

A gift to your own grantor trust doesn’t avoid the problem

Assets in an irrevocable grantor trust, funded by a completed gift and not included in your estate, don’t get a basis adjustment at your death, according to the IRS in Rev. Rul. 2023-2 (2023). The ruling says the asset “was not acquired or passed from a decedent” as § 1014(b) defines it. Paying the trust’s income tax as its grantor doesn’t change that. The fix is a swap power used before death, covered below. See irrevocable trusts and the step-up.

A deathbed gift to a parent doesn’t buy a step-up

If appreciated property was given to the decedent during the one-year period ending on the date of death and passes back to the donor or the donor’s spouse, the donor takes back the decedent’s old basis, under IRC § 1014(e). A deathbed gift to a parent, left back to you by the parent’s will, doesn’t buy a step-up.

Why the gift saves estate tax only on growth

The federal estate tax is computed on the taxable estate plus “adjusted taxable gifts,” meaning taxable gifts made after 1976 that aren’t otherwise in the gross estate (IRC § 2001(b)). Gift tax already payable on those gifts is then subtracted. In plain terms, a $10 million gift is counted at $10 million in your estate tax calculation whether you die next year or in twenty years.

The estate tax saving is therefore 40% of the growth after the gift (IRC § 2001(c)). The income tax cost, if your heirs sell after your death, is 37.1% of the whole gain in California, the gain you built up before the gift plus all the growth after it. A dollar of growth after the gift nets 2.9 cents, and every dollar of gain you built up before the gift costs 37.1 cents.

How much growth a gift needs before it beats holding

A gift of an asset with no basis, made inside the exemption, needs to grow to about 13.8 times its value by your death before it beats holding, if your heirs would sell after you die (computed from IRC §§ 1014, 1015 and 2001, 2026 rates).

Call the gift’s value V, your basis B, and the growth after the gift G. Holding costs 40% estate tax on V + G and no income tax, because the basis steps up. Giving costs 40% estate tax on V (the add-back) and 37.1% income tax on the whole gain, V plus G minus B. The gift comes out ahead only when 40% of G is more than 37.1% of that gain, which works out to G greater than 12.8 times your built-in gain (V minus B).

The 12.8 figure assumes the heir pays California’s 13.3%. At the 23.8% federal rate alone, the break-even drops to about 1.5 times the built-in gain. California’s rate makes a gift of low-basis assets far costlier here.

The second column in the chart is a different case: an estate already past the exemption, so the gift pays 40% gift tax, and a donor who lives more than three years. Gift tax paid on a gift made within three years of death is added back to the gross estate (IRC § 2035(b)). After three years it stays out, and paying it shrinks the estate. Part of the gift tax is also added to the donee’s basis, in the same proportion as the gift’s net appreciation bears to its value (IRC § 1015(d)(6)). Both rules help the gift, and the break-even drops sharply in that column.

Change one fact in Martin’s case: he used up his exemption years ago, so the gift pays $4,000,000 of gift tax, and he lives more than three years. On the same numbers the gift still trails holding, by about $258,400. It takes a higher basis or more growth to tip it.

If your heirs would hold the asset for life, the income tax column shrinks or disappears, and the gift looks better. That depends on assets the family won’t sell, and on the heirs’ own estates, which will face the same question.

When gifting a low-basis asset still wins

• The gift tax is real and you’ll live three years. For an estate already past the exemption, a gift that pays 40% gift tax and stays out of the estate for three years can beat holding, as the second column above shows. The higher the basis, the easier the win. A net gift, where the children agree to pay the gift tax, is a different story. In Diedrich v. Commissioner (1982) 457 U.S. 191, parents gave low-basis stock on that condition, and the Court held they realized income to the extent the gift tax the children paid exceeded the parents’ basis.
• The asset will be sold during your life anyway. If the company is being sold in two years, there’s no step-up to lose. Give early, before the sale is locked in, and value the gift with a qualified appraisal.
• You give to a grantor trust and plan the swap. A power to reacquire trust assets by substituting property of equivalent value doesn’t by itself pull the trust into your estate, if the trustee must confirm the values are equal and the swap can’t shift benefits among beneficiaries (Rev. Rul. 2008-22). In Estate of Jordahl v. Commissioner (1975) 65 T.C. 92, a power to substitute trust property of equal value didn’t let the grantor alter the trust, and wasn’t an incident of ownership in the insurance policies it held. The IRS acquiesced in the result and relies on the case in Rev. Rul. 2008-22. Swapping cash in for the low-basis asset before death brings that asset back into your estate for the step-up, while the growth already outside stays out.
• The family will hold for a generation. Long-term real estate the heirs plan to keep, refinance and never sell is the main case. Put that plan in writing in the file, because the math turns on it.

What to give instead

Give cash. Give high-basis assets, such as recently bought securities or property bought near today’s value. Give assets you expect to grow fastest that also carry little built-in gain, such as a new venture’s units at formation. Keep the low-basis assets in your own name or your revocable trust, where they’ll get the step-up. For the cases where the low-basis asset has to leave the estate, use a grantor trust with a swap power and a calendar reminder to use it.

Where California changes the math

California taxes the gain as ordinary income

California doesn’t have a lower rate for capital gains, according to the Franchise Tax Board. A Californian’s gain is taxed at up to 13.3% on top of the federal rates, which is what turns a 23.8% federal cost into 37.1% and shrinks the gift’s margin to 2.9 cents per dollar of growth. California has no estate tax of its own to offset that; its estate tax is tied to the federal credit for state death taxes (R&TC § 13302), and that credit, IRC § 2011, has been repealed (26 U.S.C. § 2011).

Community property gets two step-ups that a gift gives up

When a spouse dies, the surviving spouse’s half of community property also gets a new basis, as long as at least half of the community interest was in the decedent’s gross estate (IRC § 1014(b)(6)). A married couple who holds a low-basis asset as community property can get a full step-up at the first death and another at the second. A lifetime gift of that asset gives up both. A couple who wants the double step-up on separate property needs a written transmutation with an express declaration, under Fam. Code § 852(a) and Estate of MacDonald (1990) 51 Cal.3d 262. See the community property step-up and transmutation agreements.

A gift of real estate adds a property tax question and no relief

For real estate, the same basis rules apply, and Prop 19 adds a property tax layer. A gift of California real estate to a child is a change in ownership unless the parent-child exclusion applies, and since February 16, 2021 that exclusion covers only a principal residence or family farm, with a claim filed (R&TC § 63.2). It applies the same way to a gift and to an inheritance, so a lifetime gift buys nothing on property tax. See the Prop 19 parent-child exclusion, deeding your house to your kids and Prop 19 planning.

Before you make the gift

This matters most to families with large unrealized gains in stock, real estate, or a closely held business who’ve been told to “use the exemption” with gifts, and to families who already made those gifts to a grantor trust and need a plan to get the basis back. It also matters to anyone holding an asset worth less than they paid who is about to give it away. Before any gift above $19,000 to one person in 2026, see gift tax in 2026 for the return you’ll need, and run the numbers on the estate tax calculator.

Working with Ridley Law

The call is for California families deciding which assets to give and which to hold, or repairing a gift that left low-basis assets outside the estate. The first call is free and runs 30 minutes, by phone or Zoom. I work alongside your CPA and, where the matter calls for it, co-counsel. Work at this level is built for each family and quoted in writing before any drafting starts.

Book my 30-minute call or call 805-244-5291.

Frequently asked questions

Is it better to gift appreciated stock or leave it at death?

Usually leave it at death. The heir gets a basis equal to the stock’s value at death (IRC § 1014(a)), while a gift carries over your basis (IRC § 1015(a)). A gift wins mainly when the estate is past the exemption and you’ll live at least three years after paying gift tax, or when the stock will be sold during your life anyway.

Does a gift to my grantor trust get a step-up when I die?

Not under Rev. Rul. 2023-2. The IRS says assets in a grantor trust that aren’t in your estate keep your basis. A swap power used before death can bring the asset back into your estate for the step-up.

Can I give appreciated property to my parent and inherit it back with a step-up?

Not if your parent dies within one year of the gift and the property passes back to you or your spouse. In that case you take back your parent’s old basis, which is your own basis (IRC § 1014(e)).

Should I give away an asset that’s lost value?

No. For figuring a loss, the donee’s basis is the asset’s value at the gift if that’s lower than yours (IRC § 1015(a)), so the loss is gone. Sell it yourself, take the loss on your return, and give the cash.

Do California couples get a double step-up on community property?

Yes. At the first death, both halves of community property get a new basis if at least half of the community interest was in the decedent’s gross estate (IRC § 1014(b)(6)). The survivor’s assets get another at the second death. A lifetime gift of the asset gives up both.

Does California have a gift tax or an estate tax?

No gift tax, and no estate tax that applies today. California’s estate tax is tied to the federal credit for state death taxes (R&TC § 13302), and that credit (IRC § 2011) has been repealed. The California cost of a gift is the 13.3% income tax on the gain your heirs inherit.

I already gave low-basis assets to a trust. Can I fix it?

Often. If the trust is a grantor trust with a power to substitute assets of equal value, you can swap cash in for the low-basis assets before death (Rev. Rul. 2008-22). If it has no such power, a decanting or court modification may add one, depending on the trust terms.