A family in Brooklyn inherits a multi-family property their parents purchased in 1982 for $150,000. Today, that same property appraises for $2.4 million. If the parents had transferred the deed to their children during their lifetime as a well-meaning gift, the children would have inherited the original $150,000 tax basis. Upon selling the building, they would face capital gains taxes on the $2.25 million of appreciation—a staggering liability that could easily consume a third of the property’s value when factoring in federal, state, and city tax rates.
But because the parents held the property until death—specifically, funded inside a revocable living trust—the outcome changes entirely. The children inherit the property at its current market value of $2.4 million. When they sell it for that amount a month later, their taxable capital gain is precisely zero.
At Morgan Legal Group, we spend a significant amount of time untangling the confusion between probate avoidance, estate taxes, and capital gains taxes. Many people assume that moving assets into a trust automatically triggers adverse tax consequences, or conversely, that a basic trust shields them from every tax in existence. Neither is true. Understanding how a living trust interacts with capital gains tax requires deliberate planning and an accurate view of how the tax code treats inherited wealth.
The Mechanics of the Stepped-Up Basis
Capital gains tax applies to the profit realized upon selling an appreciated asset. Your basis is generally what you paid for the asset, plus the cost of any major capital improvements. If you buy a stock for $100 and sell it for $500, you owe capital gains tax on the $400 of profit.
The tax code provides a massive advantage for inherited assets—the stepped-up basis. When you pass away, the cost basis of the assets included in your estate is stepped up to their fair market value on your date of death.
A revocable living trust is designed specifically to preserve this benefit. Because you retain the right to alter, amend, or revoke the trust during your lifetime, the Internal Revenue Service considers you the owner of the trust’s assets. You file taxes using your own Social Security number, and you report income just as you always have. When you die, those assets are included in your gross estate for tax purposes, which is exactly what triggers the step-up in basis for your beneficiaries. They receive the private transfer of wealth that a trust provides without forfeiting the single most powerful capital gains tax advantage available under the law.
The Danger of the “Quick Deed” Strategy
Often, clients sit in my office and suggest a shortcut. They want to avoid Surrogate’s Court, so they propose simply adding their children to the deed of their primary residence. We strongly advise against this.
When you gift an asset during your lifetime, the recipient takes your original cost basis—this is known as a carryover basis. By adding your child to your deed, you are making a lifetime gift of half the property’s value. You have just transferred half of your built-in capital gains liability directly to your child. Furthermore, if your child faces a lawsuit, a divorce, or a bankruptcy, your home is now exposed to their creditors.
Stewardship.
That is what estate planning is actually about. It is not merely about avoiding probate—it is about transferring wealth in the most protective, tax-efficient manner possible. A revocable living trust achieves the goal of bypassing Surrogate’s Court while keeping the asset entirely under your control and preserving the full stepped-up basis for your heirs. To accomplish this in New York, the trust must be executed with strict adherence to state law. Under EPTL § 7-1.17, a lifetime trust is only valid if it is in writing, executed by the creator and at least one trustee, and either acknowledged like a deed or signed by two witnesses. A poorly drafted or improperly executed trust can fail, dragging your family right back into the court system you sought to avoid.
Fiduciary Duty and the Timing of Asset Sales
Once you pass away, your revocable trust becomes irrevocable, and your successor trustee assumes control. This individual now bears a fiduciary duty to manage and distribute the trust assets according to your instructions. Their decisions regarding how and when to liquidate assets will directly impact the capital gains tax reality for your beneficiaries.
Under New York law, specifically EPTL § 11-1.1, a trustee generally holds the statutory power to sell, mortgage, or lease real property unless the trust document explicitly restricts it. If the trust holds a portfolio of real estate or highly appreciated stocks, the trustee must act prudently. If they sell the assets shortly after your death, the capital gains will be minimal or non-existent due to the step-up in basis. However, if the trustee holds onto a property inside the trust for several years before selling, any appreciation that occurs after your date of death will be subject to capital gains tax.
Trustees must also consider the tax brackets of the trust itself versus the beneficiaries. Trusts reach the highest marginal tax brackets at much lower income thresholds than individuals do. A deliberate trustee will work alongside legal and tax counsel to ensure that if capital gains are realized, the resulting tax burden is managed efficiently—often by distributing the proceeds and the accompanying tax liability to beneficiaries who are in lower personal tax brackets.
Separating Capital Gains from Estate Taxes
We must draw a hard line between capital gains tax and the estate tax. While a revocable living trust is an excellent tool for mitigating capital gains tax for your heirs, it does absolutely nothing to reduce your exposure to the New York State estate tax.
New York imposes an estate tax on estates exceeding the state exemption amount, and it employs an aggressive tax cliff. If your estate exceeds the exemption by just 5%, the state taxes the entire estate from dollar one, not just the overage. Because a revocable trust leaves the assets in your taxable estate to secure the stepped-up basis, those assets still count toward your New York estate tax threshold.
For high-net-worth individuals facing estate tax exposure, we have to look beyond the revocable trust. In cases like this, we typically consider irrevocable structures, such as Spousal Lifetime Access Trusts (SLATs) or Qualified Personal Residence Trusts (QPRTs). These vehicles remove future appreciation from your taxable estate, but they come with different capital gains tax trade-offs. The right approach requires looking at your specific balance sheet and determining whether the estate tax or the capital gains tax poses the greater threat to your generational wealth.
Your legacy should not be left to default tax rules. If you hold highly appreciated real estate or investment accounts, schedule a 30-minute review of your existing deed and trust structure with our office to confirm your beneficiaries are protected from unnecessary tax liabilities.
