The Connection Between Capital Gains and Estate Taxes

20 January 2026

Taxes—just hearing the word might make your wallet flinch. But if you're building wealth, planning your estate, or thinking long-term about your investments, then there’s no avoiding it: you’ve got to understand how capital gains and estate taxes connect. Don’t worry though, we’re about to break it down together—with no jargon overload and no boring lecture vibe.

By the end of this post, you’ll see how these two taxes dance around each other, sometimes tripping over one another. Whether you're thinking of passing down your family home or looking at your investment portfolio through a legacy lens, this one’s for you.

What Are Capital Gains and Estate Taxes Anyway?

Before we tie these two tax types together, let’s quickly break down what they really are.

Capital Gains: Your Profit’s Price Tag

Think of capital gains as the tax you pay when your stuff increases in value—and you cash in. For example, if you buy a piece of real estate for $200,000 and sell it later for $300,000, your $100,000 profit is a capital gain. And yep, Uncle Sam wants a cut.

There are two flavors here:

- Short-Term Capital Gains: You held the asset for less than a year. These are taxed like ordinary income.
- Long-Term Capital Gains: Held for more than a year. These get a slightly friendlier tax rate—typically 0%, 15%, or 20% based on your income.

Estate Taxes: The Final Wealth Test

When someone passes away and leaves behind a significant estate, the government might want a portion of it. This is the estate tax—kind of like a toll for passing along wealth.

Not everyone’s estate pays this tax. As of 2024, the federal exemption is a whopping $13.61 million per person. That means if your estate is worth less than that, you're in the clear federally. State estate taxes? That’s a whole different story—and it depends where you live.

So, What’s the Connection?

Capital gains and estate taxes aren’t entirely separate beasts. They’re tied together in a way that can either save your heirs a ton of money or set them up for a big-time tax bill.

Here's the deal: what happens to your assets when you die directly affects how much capital gains tax your heirs might have to pay. Let’s get into the nitty-gritty.

The Magic of the Step-Up in Basis

This is where things get juicy—and surprisingly helpful. When someone inherits an asset (like a home, stocks, or land), they don’t inherit it at the original purchase price. Instead, they get what’s called a step-up in basis.

An Example Because Tax Talk Gets Dry

Let’s say your grandma bought a house in 1980 for $50,000. It’s worth $600,000 now. If she sold it before passing away, she’d owe capital gains tax on the $550,000 gain.

But if she passes the house down to you, and you sell it for $600,000 shortly after her death, your cost basis isn’t $50,000 anymore—it’s $600,000. That’s the value at the time of inheritance. So your capital gain? Zero.

Not bad, right?

That’s the “step-up.” It resets the value of the asset for tax purposes, wiping out decades’ worth of capital gains. This is a massive tax break for heirs and a key reason why estate planning matters.

When the Estate is Too Big… Tax Comes Knocking

Of course, nothing golden stays without strings.

If the estate’s value exceeds that $13.61 million threshold (or your state’s exemption, if lower), the estate itself might owe taxes before anything is distributed. And if assets need to be sold to pay those taxes, capital gains can come into play.

Here’s how it might cascade:

1. A wealthy estate includes real estate, stocks, business interests, and more.
2. The estate owes estate taxes.
3. To pay those taxes, heirs might need to sell some inherited assets.
4. Depending on timing and how long the estate holds those assets before selling, capital gains taxes might apply.

In some scenarios, the estate might not get the step-up in basis if the asset grows in value after the person’s death but before it’s sold. That’s where things get murky, fast.

The Biden Administration and Policy Changes

Tax law is never static, and recent years have seen whispers (and some shouts) about removing the step-up in basis. Why? Well, it’s a massive tax loophole for wealthy families.

What’s the Debate?

Some argue that the step-up allows ultra-wealthy families to pass on billions without ever paying capital gains taxes on decades of appreciation.

On the flip side, critics of removing the step-up say it would hurt middle-class families trying to pass on modest investments or family homes without liquid assets to cover big tax bills.

For now, the step-up in basis remains. But keep your eyes on this—it’s a policy seesaw that could fundamentally shift how estates and capital gains interact.

Strategies to Consider: Protecting What You’ve Built

Understanding how capital gains and estate taxes connect isn’t just about trivia. It’s about making smart moves to protect your legacy. Here are a few strategies the savvy (and their advisors) use:

1. Gifting While You’re Alive

You can gift up to $17,000 per person per year (as of 2024) without triggering gift taxes. Over time, this can reduce the size of your estate and potentially keep you under that estate tax threshold.

But be careful—gifting appreciated assets may trigger capital gains for the person you give them to. They inherit your original cost basis, not a step-up. Ouch.

2. Using Trusts Wisely

Certain types of trusts can help you keep control of your assets while reducing estate tax liability. A grantor retained annuity trust (GRAT), for instance, allows you to pass on assets with little or no estate tax if market conditions work in your favor.

Some trusts can also be structured to defer or reduce capital gains. This is where a good estate planning attorney earns their keep.

3. Charitable Contributions

Donating appreciated assets to charity can eliminate capital gains taxes and reduce estate size. Win-win. Plus, who doesn’t love a bit of legacy giving?

4. Buy Life Insurance to Cover Taxes

Some high-net-worth families buy life insurance policies specifically to cover expected estate taxes. That way, heirs don’t have to sell appreciated assets quickly and deal with both capital gains and estate tax messes.

Key Takeaways: What You Really Need to Know

So, what’s the bottom line here? Let’s tie it all up with a bow:

- Capital gains tax is about profits from selling assets.
- Estate tax is about transferring wealth when someone dies.
- The step-up in basis can save heirs from massive capital gains taxes.
- Wealthy estates might still owe estate taxes, which can complicate things more.
- Smart planning—like gifts, trusts, and insurance—can keep your legacy intact and tax-efficient.

Ultimately, understanding how these taxes interact isn’t just for the rich. It’s crucial for anyone hoping to pass down a home, investments, or a small business. And while the rules might seem complex (and they are), avoiding them doesn’t make them go away.

Final Thoughts: Plan Now or Pay Later

Taxes are inevitable—but big tax bills often aren’t. Taking time now to understand the connection between capital gains and estate taxes is one of the smartest financial moves you—or your heirs—can make.

And hey, why let the IRS write the final chapter of your wealth story? With the right planning, you control the narrative.

Time to grab a financial planner, have that slightly uncomfortable family conversation, and put a solid plan in motion. Your future self—and your family—will thank you.