Basis Planning for Highly Appreciated Real Estate
Reduce your capital gains before a sale.
How Basis Works and Why It Matters for Appreciated Property
Real estate that has grown far above its original purchase price creates a significant tax problem when it’s sold, because capital gains tax applies to the entire difference between what you paid and what you receive. Basis planning addresses that problem by raising, deferring, or eliminating the taxable gain through legal strategies before a sale or transfer happens. For property owners in Washington, D.C., where values have risen sharply over decades, the amount at stake can be substantial.
Tax basis is the starting value used to calculate your gain when you sell. The lower the basis relative to the sale price, the larger the taxable gain. For property held a long time, that gap can represent decades of appreciation.
A property bought for $200,000 and now worth $800,000 carries a $600,000 unrealized gain. If sold, that gain is subject to federal long-term capital gains rates that can reach 20%. Washington, D.C. taxes capital gains as ordinary income on top of that, which can push large gains into a high local tax bracket. The combined federal and D.C. burden on a single appreciated property sale can be significant.
Stepped-up basis is the most important rule in this area. Under Internal Revenue Code Section 1014, when someone inherits property, their basis resets to the fair market value on the date of the original owner’s death. Using the same example, if the parent who bought the property at $200,000 holds it until death, the heir’s basis becomes $800,000. A sale immediately after inheriting may trigger little to no capital gains tax, effectively erasing decades of built-up gain.
The stepped-up basis rule doesn’t apply to gifts made during life. If you give appreciated property to someone while you’re alive, they inherit your original low basis. That’s called carryover basis, and it shifts the tax burden to the recipient when they eventually sell. Holding appreciated property until death rather than gifting it during life often produces a much better tax outcome for the people receiving it.
Other tools, including installment sales, charitable remainder trusts, and qualified opportunity zone investments, can spread or defer gains when holding until death isn’t practical or isn’t the goal. Each approach has its own rules and tradeoffs, and the right choice depends on the size of the gain, the owner’s timeline, and what they want to do with the property.
Basis Planning Strategies for Washington, D.C. Property Owners
Several strategies can reduce or defer the tax on appreciated real estate. The right combination depends on whether the owner wants to hold the property, sell it, give it away, or pass it to heirs.
Hold Until Death for the Stepped-Up Basis
The simplest strategy is to hold appreciated property until death, allowing the stepped-up basis under IRC Section 1014 to reset the heir’s starting value to the current market price.
For property owners who don’t need the sale proceeds during their lifetime, this approach eliminates the built-in gain entirely for the next generation. The property can be held in a revocable living trust without affecting the step-up, since revocable trust assets still receive a stepped-up basis at the grantor’s death.
Installment Sales
An installment sale lets the owner sell the property but receive the sale price in payments over multiple years rather than all at once. This spreads the capital gains tax across the payment period rather than triggering the entire liability in a single tax year.
For D.C. property owners in high-income years, spreading the gain can lower the effective tax rate applied to it. The structure of an installment note matters, particularly if the owner dies while payments are still outstanding, because the step-up at death may apply only to the unpaid balance, not the full original gain.
Charitable Remainder Trusts
A charitable remainder trust allows an owner to transfer appreciated property into the trust, which then sells it without recognizing capital gains tax. The trust pays the owner an income stream for life or a set period, and the remaining assets go to charity after the owner’s death.
The owner also receives a partial charitable deduction when the trust is funded. This strategy works best when the owner has significant charitable intent and wants ongoing income rather than a lump sum.
Qualified Opportunity Zone Investments
Selling appreciated real estate and reinvesting the gain into a Qualified Opportunity Zone fund allows the owner to defer recognition of the original gain and potentially reduce it, depending on how long the investment is held. The tax rules around opportunity zones are specific and have changed over time, so this strategy requires careful analysis of the current rules before it’s implemented.
Gifting Strategies With a Basis Step-Up Goal
Some basis planning strategies combine gifting with a long-term goal of achieving a step-up. Transferring appreciated property to a spouse, for example, doesn’t trigger capital gains tax on the transfer, and the survivor may receive a step-up at the first spouse’s death depending on how the property was titled.
In D.C., where community property rules don’t apply, the specific ownership structure on the deed affects how much of the basis gets stepped up when the first owner dies.
Situations That Complicate Basis Planning for Real Estate
The stepped-up basis rule and the strategies that rely on it work well in straightforward situations, but several real-world facts can limit or shift the analysis in ways worth knowing.
Partial Sales Before Death
If an owner sells part of an appreciated property before death, that portion loses the benefit of the step-up. Only assets held until death receive the basis reset. Selling a fractional interest, even a small one, triggers capital gains tax on the appreciated amount attributable to that share and removes it from step-up planning permanently.
Depreciation Recapture on Rental Property
For owners who have claimed depreciation deductions on rental real estate, a stepped-up basis at death doesn’t erase the recapture liability. The IRS taxes prior depreciation as ordinary income under a separate recapture rule that applies regardless of what happens to the property’s basis. Owners of rental property need to account for this separately when evaluating how much tax their estate will actually owe.
Joint Ownership and Partial Step-Ups
When appreciated property is held as tenants in common in Washington, D.C., the step-up at death applies only to the deceased owner’s share. The surviving co-owner’s share retains its original basis.
Community property rules in some other states allow a full step-up on both halves when one spouse dies, but D.C. doesn’t follow community property law. How the deed reads in D.C. directly affects how much of the gain gets erased at death.
Proposed Legislative Changes
The stepped-up basis rule has been a target of proposed federal tax legislation at various points, and proposals to eliminate or limit it have surfaced in recent budget discussions.
Nothing has been enacted as of this writing, but owners of large appreciated real estate holdings in D.C. should track legislative developments and maintain a flexible plan that doesn’t depend entirely on current law remaining unchanged.
What Basis Planning Looks Like in Practice for D.C. Property Owners
The planning process for appreciated real estate follows a consistent sequence, though the right strategy varies by situation. Here’s what each stage typically involves for Washington, D.C., property owners.
Establishing the Current Basis and Gain
The first step is determining what the property’s current basis actually is. This means starting with the original purchase price, adding any capital improvements made over the years, and subtracting any depreciation claimed for rental use. The difference between that adjusted basis and the current fair market value is the unrealized gain.
This calculation also needs to factor in any D.C. estate tax exposure, since the District has its own estate tax with an exemption lower than the federal threshold.
Clarifying the Owner’s Goals
The right strategy depends on what the owner actually wants to do with the property. Someone who wants to pass it to their children intact has different planning needs than someone who wants to sell it and reinvest the proceeds or donate it to charity.
Mapping out the goal upfront prevents time spent analyzing strategies that don’t fit the situation.
Selecting and Documenting the Strategy
Once the goal is clear, an attorney drafts the appropriate documents, which may include a revocable living trust to hold the property, a charitable remainder trust, an installment sale agreement, or updates to the deed and beneficiary designations.
For properties transferred into a trust or sold through a structured arrangement, the documents need to be completed and recorded correctly. A new deed is recorded with the D.C. Office of Recorder of Deeds when the ownership structure changes.
Reviewing the Plan Over Time
Tax law changes, property values shift, and the owner’s circumstances evolve. A plan that fits today may need adjustment in a few years. Reviewing the basis planning strategy every three to five years, or after any significant change in the tax rules or the property’s value, keeps the approach aligned with the current landscape.
Talk to a D.C. Estate Planning Attorney About Your Appreciated Property
Real estate that has significantly increased in value since purchase carries a growing tax liability that compounds over time. Whether the plan is to hold the property, eventually sell it, pass it to the next generation, or donate it, the decision about timing and structure can determine how much of that gain is actually taxable and when.
If you own appreciated real estate in Washington, D.C. and haven’t reviewed your basis planning options, speaking with an estate planning attorney can help you understand how much tax is at stake, which strategies fit your goals, and what the timing implications are. The sooner the analysis is done, the more options are typically available.
At Kevin C. Martin, Attorney at Law, PLLC, we work with Washington, D.C. property owners on basis planning and estate tax strategy. Contact our office to discuss your real estate holdings and what options are available to you.
FAQs About Basis Planning for Appreciated Real Estate
What is a stepped-up basis, and why does it matter at death?
When a property owner dies, the tax basis of their real estate resets to fair market value on the date of death under IRC Section 1014. This step-up can eliminate years of built-in capital gain, so heirs may sell the property with little or no federal or D.C. capital gains tax owed.
Can I give appreciated property to charity and avoid capital gains tax?
Yes. Donating real estate directly to a qualified charity typically allows the owner to bypass capital gains tax on the built-in gain entirely. The owner may also claim a charitable deduction based on the property’s full fair market value at the time of the gift.
What happens to the basis when real estate passes through a trust?
Property held in a revocable living trust still receives a stepped-up basis at death, the same as property held outright. Property transferred to an irrevocable trust during life generally doesn’t get the step-up, and the original carryover basis follows the asset into the trust.
Does Washington, D.C. have its own capital gains tax on real estate?
Yes. D.C. taxes capital gains as ordinary income, so large gains on appreciated property can push an owner into a high local tax bracket. Basis planning matters at both the federal and D.C. levels, and the combined tax rate can be significant for longtime property owners in the District.
Is basis planning only relevant for very large real estate portfolios?
No. A single rental property or a family home held for many years can carry a substantial unrealized gain. Basis planning for highly appreciated real estate applies broadly to D.C. property owners, not just those with large portfolios, and the stakes are often significant even for a single property.