A client recently came to my office with a common New York story. Her parents bought their home in Queens in 1982 for about $120,000. Today, it’s worth nearly $1.4 million. She and her brother, the intended heirs, plan to sell the property after their parents pass away. Her question was direct: “When we sell, will we have to pay capital gains tax on that entire appreciation?”
This is one of the most frequent questions I hear, and it rests on a popular misconception. Many people believe that putting a house into a trust—any trust—magically wipes away tax liability. The type of trust you choose determines the outcome. The wrong kind can fail to solve the problem and may create a significant, avoidable tax bill for your children.
The Real Goal: A “Step-Up in Basis”
The tax implications of transferring a home drive this entire discussion. When you sell an asset that has appreciated, like real estate, the profit is potentially subject to capital gains tax. The “gain” is the difference between the sale price and your “cost basis”—what you originally paid, plus the cost of capital improvements.
For the family from Queens, the basis is $120,000. If their parents sold the house today for $1.4 million, they would face a capital gain of $1.28 million. Federal law provides a home sale exclusion—up to $500,000 for a married couple—but a substantial taxable gain would remain.
A powerful provision in the U.S. tax code changes this for inherited property. Under Internal Revenue Code § 1014, when an heir inherits an asset, its cost basis is “stepped up” to the fair market value on the date of the owner’s death. The slate is wiped clean. If the children inherit the house when it’s worth $1.4 million, their new cost basis becomes $1.4 million. If they sell it immediately for that price, their capital gain is zero. No tax is due.
This step-up in basis is the real prize. The primary goal of any trust strategy involving an appreciated home must be to preserve it for your heirs.
Revocable Trusts vs. Irrevocable Trusts
Whether your trust preserves the step-up in basis depends on its structure. Trusts fall into two general categories for this purpose—revocable and irrevocable.
A revocable living trust is the most common estate planning instrument we create for families. It’s flexible—you can change it, amend it, or revoke it entirely during your lifetime. You transfer your assets, including your home, into the trust, but you retain full control as the trustee. For tax purposes, the IRS disregards a revocable trust. You are still treated as the owner. Because the house is still considered part of your taxable estate upon death, it qualifies for the full step-up in basis. Your heirs get the benefit of avoiding probate and avoiding capital gains tax.
An irrevocable trust is a different matter. Once you create it and place assets inside, you generally cannot take them back. You give up control. This is often done for specific purposes, like protecting assets from creditors, planning for Medicaid eligibility, or reducing a large estate to minimize estate taxes. Herein lies the danger. If you make an outright gift of your house to a standard irrevocable trust, you may also gift away your low cost basis. Your children, as beneficiaries, could be stuck with the original $120,000 basis, forcing them to pay the capital gains tax you were trying to avoid. It can be a devastating financial mistake.
Intentional Drafting is Everything
This does not mean an irrevocable trust is never the right tool. For long-term care planning or for very high-net-worth individuals, an irrevocable trust is a prudent part of a generational plan. It must, however, be drafted with extreme care.
We can structure an irrevocable trust—often as an “Intentionally Defective Grantor Trust”—in a way that removes the asset from your estate for some purposes (like Medicaid qualification) but keeps it within your estate for tax purposes, thereby preserving the step-up in basis. This requires precise language and a deep understanding of both federal tax law and New York trust law. The creation of these instruments is governed by New York’s Estates, Powers and Trusts Law, with formal requirements for lifetime trusts outlined in EPTL § 7-1.17.
Stewardship. This is about more than just avoiding probate. It is about making a deliberate, informed decision that protects the value you built over a lifetime, ensuring it passes to the next generation without an unnecessary tax burden.
The tax consequences of transferring your home are not trivial. Before you sign any deed or trust document, a prudent first step is to inventory your assets and clarify your intentions for your heirs. We often begin this process with a review of your property’s current value and title to determine the most effective path for your family’s legacy.
