Estate tax vs. capital gains tax: When gifting assets may cost more than it saves

Estate planning discussions often begin with a simple idea: gift assets during life to reduce estate taxes.

While that idea is intuitive, it is also incomplete. The real objective of estate planning is not to minimize a single tax, but to maximize how much wealth ultimately reaches the next generation after all taxes are paid.

For families with significant wealth, particularly wealth concentrated in highly appreciated assets such as stocks or real estate, focusing solely on estate taxes can lead to decisions that look effective on paper but reduce overall family wealth in practice. This is because estate taxes are only one part of the equation. Income taxes, especially capital gains taxes, often play an equally important role.

The key is to consider estate and income taxes together to understand when gifting during life leads to a better outcome or when it may be better to leave assets at death to heirs in an inheritance.

Estate tax and capital gains tax: two systems, one asset

Estate and gift taxes apply when wealth is transferred. When assets are gifted during life or transferred after death, their value is measured against the individual’s available federal estate and gift tax exemption, which is $15 million per individual in 2026. Amounts transferred above that exemption to a recipient other than a spouse are generally subject to a federal estate tax rate of up to 40%.

Capital gains taxes apply when assets are sold. The tax is based on the difference between the sale price and the asset’s tax cost basis (typically, what the owner originally paid for it). For long-held assets, this appreciation can be substantial.

The key point is that these two tax systems interact—and often pull planning decisions in opposite directions.

Gifting appreciated assets: the capital gains and step-up in basis trade off

When assets are gifted during life, the original purchase price—or cost basis—transfers with them. If the recipient later sells the assets, capital gains tax is owed on the difference between the sale price and the original purchase price.

Assets held until death are treated very differently. In most cases, they receive a full “step-up” in basis to fair market value at the date of death. This permanently eliminates capital gains tax on all appreciation that occurred during the owner’s lifetime.

As a result, holding assets until death may eliminate capital gains taxes altogether on those assets. However, the asset’s full value may then be included in the donor’s taxable estate, and, to the extent it exceeds the available $15 million exemption, estate taxes could be incurred or increased. The key is understanding how these two taxes interact and which one has the greater impact on your situation.

Example: gifting appreciated assets vs holding for a step-up in basis

Let’s assume an individual owns shares of a stock worth $15 million that they originally purchased for $1 million.

If the shares are gifted, the original $1 million cost basis will carry over with them. After ten years of growth at 7% per year, the stock would be worth approximately $30 million. If the heirs sell the shares at that time, they would recognize roughly $29 million in gain, resulting in approximately $6.9 million in capital gains tax (assuming current tax rates).

Now assume those same shares were not gifted but instead held by the individual until their death 10 years later. The shares would grow to the same $30 million value, but no capital gains tax would be owed by the heirs due to the step-up in basis at death. Instead, they may be subject to a 40% estate tax for the value that exceeds the federal estate tax exemption (assumed to be about $19 million at that time). That leaves roughly $11 million subject to estate tax, resulting in a tax of approximately $4.4 million.

What’s the difference?

At first glance, gifting may seem attractive because if the estate is projected to exceed the federal estate tax exemption, removing the $15 million asset today could prevent both its current value and its future growth from being subject to estate tax of up to 40%. However, that view only considers estate tax. When both estate and capital gains taxes are evaluated together, the outcome changes.

• Gift strategy: About $6.9 million in capital gains tax
• Hold strategy: About $4.4 million in estate tax and no capital gains tax

In this example, holding the asset until death results in lower total taxes and ultimately leaves more wealth to heirs.

Gift vs. Hold Strategy Comparison (10-Year View)

10-Year Comparison: Gift Today vs. Hold Until Death

Even with a full exemption available, holding the highly appreciated asset until death rather than gifting during life results in about $2.5 million more for heirs.

 

How time horizon affects gifting appreciated assets

How long you expect to hold an asset can significantly affect whether gifting makes sense.

The step-up in cost basis at death can be especially valuable when:

• The asset was purchased long ago at a much lower price
• Heirs are likely to sell the asset
• The expected timeframe is relatively short

Gifting removes future growth from your estate, but that benefit builds slowly over time. By contrast, giving up the step-up in basis can create a large capital gains tax bill if the asset is later sold.

When the timeframe is shorter, the potential capital gains tax savings from holding the asset may outweigh the estate tax savings from gifting.

Choosing the right assets to gift: basis, growth, and trust considerations

Which assets should be gifted, and which should be retained? In many cases, low basis assets that are likely to be sold benefit from being held until death. Assets with higher cost basis, assets subject to potential valuation discounts (e.g., lack of control, lack of marketability), or assets with long-term growth potential are often better candidates for gifting.

Many gifts are made to trusts for asset protection, control or long-term planning purposes. While trusts can be powerful tools, they reach the highest income tax rates very quickly.

When low basis or income-producing assets are placed into trusts designed to accumulate wealth, income taxes can accumulate over time. This ongoing tax drag may reduce the overall benefit of an otherwise sound estate plan and should be considered during the planning process.

When gifting low-basis assets can still work

Low-basis assets are not automatically poor gifting candidates. When transferred to flexible grantor trusts, they may later be exchanged for higher-basis assets, preserving the opportunity for basis step-up while shifting future appreciation out of the estate.

Similarly, discounted interests in closely held businesses or investment partnerships can allow more economic value to be transferred using less of the donor’s lifetime exemption, making them particularly efficient assets to gift.

The key insight is simple: asset selection matters just as much as structure.

What successful planning really looks like

Effective planning rarely relies on a single strategy. It often involves a combination of approaches: retaining certain assets to capture basis step-up, selectively gifting assets where the economics clearly favor transfer, and planning for income taxes alongside estate taxes.

Lifetime gifting remains a powerful planning tool, but it is not a one-size-fits-all solution.

For families with highly appreciated assets, particularly those with very low cost basis, the value of basis step-up can exceed the estate tax savings of early gifting. The right question is not simply whether to gift, but what to gift, when, and under what structure.

Illustrative assumptions: The $15 million asset is assumed to grow at 7% annually over ten years, resulting in an approximate future value of $30 million. Capital gains tax of approximately $6.9 million reflects a 23.8% tax rate applied to the $29 million of appreciation above the $1 million original cost basis. The federal estate tax exemption is assumed to be $15 million today and to grow at 2.5% annually to approximately $19 million over ten years, with estate tax applied at a 40% rate to amounts above the exemption. State income and estate taxes may apply. Figures are rounded and simplified for illustrative purposes.