For most families, it is better tax-wise for your kids to inherit assets that have grown in value. Giving those assets as gifts during your lifetime can cost your family much more in taxes. The reason comes down to one powerful tax rule called the step-up in basis.
What Is Step-Up in Basis?
When someone dies, most of their assets are revalued to fair market value on the date of death. This is called a step-up in basis. It comes from Internal Revenue Code Section 1014. Your children get assets at a step up in basis. This can erase decades of capital gains.
Here is a real-world example. Say you bought your home in 1995 for $150,000. Today it is worth $550,000. If you sell it yourself, you could owe capital gains tax on up to $400,000 of gain (minus any exclusions that apply).
But if your children inherit that home, their cost basis resets to $550,000. If they sell it for $560,000, they owe capital gains tax on only $10,000. Four hundred thousand dollars of gain goes away. That is the power of leaving assets to heirs rather than gifting them now.
What Happens When You Gift Instead
When you give an asset to someone during your lifetime, they get your original cost basis. This is called carryover basis. Using the same example:
- You gift the house to your daughter while you are alive
- Your original basis of $150,000 transfers to her
- She sells it for $550,000
- She owes capital gains tax on $400,000 of gain
That tax bill could be $60,000 to $100,000 or more. It depends on her income and tax rates. The gift cost your family far more in taxes than inheritance would have.
The Gift and Estate Tax Exemption
The federal government combines the gift and estate tax into one system. As of 2026, the lifetime gift and estate tax cutoff is about $15 million per person. That means most families will never owe federal estate tax.
But if your estate is above the cutoff, planned gifting can reduce the 40% estate tax rate.
Any gift above the yearly exclusion ($19,000 per person in 2025 and 2026) means you must file a gift tax return on IRS Form 709. Filing Form 709 does not always mean you owe tax. It simply tracks how much of your lifetime cutoff you have used. The cutoff amounts adjust for inflation over time.
Arizona's Community Property Advantage
Arizona is a community property state. This creates an extra benefit for married couples. When one spouse dies, both halves of community property get a step-up in basis. Not just the deceased spouse's half.
Say a married couple owns a home worth $600,000. They paid $200,000 for it. When one spouse passes away, the full property resets to $600,000 for the surviving spouse. This double step-up can save a lot in capital gains taxes if they decide to sell.
When Gifting Still Makes Sense
- Cash gifts. Cash does not grow in value. There is no basis issue. Yearly gifts up to the exclusion amount are fully tax-free.
- Assets that have not grown. If the asset is worth about what you paid, the basis question is neutral.
- Helping family now. Sometimes the benefit of giving money when your children need it, for a down payment, school costs, or starting a business, beats the tax savings of waiting.
- Reducing a large taxable estate. For estates above the lifetime cutoff, planned gifting can lower the 40% estate tax hit.
The Bottom Line
For assets that have grown in value, like real estate and investments, inheriting is almost always better for taxes. The step-up in basis wipes out capital gains that would otherwise create large tax bills. Before making large gifts, talk with an estate planning pro about the full tax picture for your family.
For the full Arizona walkthrough of federal estate, gift, and GST tax planning, including portability, the lifetime exemption, and annual exclusion gifts, read our pillar guide: Estate, Gift & GST Tax in Arizona: The Complete Guide.