The estate tax basics
The federal estate tax applies to estates exceeding the applicable exclusion amount — approximately $13.99 million per person (2025), or $27.98 million for a married couple using portability. Property included in the estate is taxed at a flat 40% rate on the excess.
Real estate is included at its fair market value at death, which for appreciated rental portfolios can be substantial. Most families below the exemption threshold owe no federal estate tax, but some states have lower thresholds — several states tax estates above $1–$2 million. The federal exemption is scheduled to roughly halve in 2026 if Congress does not act to extend the current levels.
The step-up: income tax benefit, estate tax cost
The same appreciation that triggers estate tax also generates the step-up in basis that eliminates income tax on that appreciation. This creates a trade-off: the step-up strategy (holding appreciated rentals until death) eliminates all income tax on the gain but includes the FMV in the estate — potentially taxed at 40%.
The math: if your combined income tax on gain would be 35% and you pay 40% estate tax instead, you're worse off with the step-up strategy for the over-threshold portion. For estates well under the exemption, the step-up is pure gain — zero estate tax and zero income tax on decades of appreciation.
Common planning strategies
Several strategies reduce estate tax while preserving some or all of the step-up. A qualified personal residence trust (QPRT) removes a personal home from the estate at a discounted value. A grantor retained annuity trust (GRAT) can transfer appreciation in excess of the hurdle rate out of the estate tax-free.
For rental portfolios, a family limited partnership (FLP) or LLC can apply minority and lack-of-marketability discounts (typically 20–40%) to the gifted interests, transferring more value using less of the lifetime gift exemption. Charitable remainder trusts allow a sale of appreciated property, income during life, and a charitable deduction. Each strategy has its own complexity and risk — model them against the doing-nothing baseline.
Frequently asked questions
What is the estate tax exemption for 2025?
The federal basic exclusion amount is approximately $13.99 million per person in 2025 (indexed for inflation). Married couples can use both exemptions ($27.98 million) with portability.
Does the step-up eliminate estate tax?
No. The step-up eliminates income tax on appreciation but the full FMV is still included in the taxable estate. The step-up and estate tax are two separate systems.
What happens to the exemption in 2026?
Under current law, the increased exemption expires after 2025 and reverts to the pre-TCJA level of approximately $7 million per person (indexed for inflation). Congress may act to extend it.
Sources
Educational information and estimates only. Not tax advice. Tax rules change and vary by situation; consult a qualified tax professional before acting.