A Tale of Two Taxes: Capital and Estate

Capital and Estate: A Tale of Two Taxes

A client holding Bitcoin, which had increased twentyfold in value, had a dilemma. Now ready to sell, the client wondered: which option would be more tax-efficient—selling the bitcoin now or leaving it to their children? Both choices present tax challenges, whether in the form of income taxes or estate taxes.

Currently, estates valued under $14 million are exempt from federal estate tax. For those below this threshold, avoiding capital gains tax becomes a significant concern.

Capital gains tax applies when you sell appreciated property, whether it’s Apple stock or a rare Chinese ceramic bowl. The federal tax rate on capital gains is 15% for persons with annual incomes between $47,026 and $518,900 and 20% for incomes above $518,900. Additionally, 42 states (43, including Washington, DC) collect capital gains taxes, with rates ranging from 2.5% in Arizona to 14% in California.

However, if appreciated property remains in your estate, your heirs benefit from a “stepped-up” basis—a major tax advantage. The new owner’s cost basis is adjusted to the property’s fair market value at the time of your death.

A Tax-Smart Scenario
Consider an Andy Warhol painting bought for $10,000 that’s now worth $100,000. If your heirs sell it for $100,000 after your death, there would be no capital gains tax.

That said, the property’s value becomes part of your taxable estate. Estate tax only applies if your estate exceeds state-specific thresholds—$4,873,200 in DC and $5 million in Maryland, for example. Estate tax rates in DC range from 11.2% to 16%, while Maryland’s rate is 16%. Virginia residents, meanwhile, have no state estate tax. For those in tax-heavy states like DC, Maryland, New Jersey, and New York, estate taxes remain a concern even if no federal estate tax applies.

Planning Strategies
If your estate is valued near or above $5 million in a tax-heavy state, consider this: selling property now means losing the time value of the money paid as capital gains tax. Deferring the sale by passing the property to your heirs may help them avoid capital gains tax altogether. Even if your estate incurs a 16% state-level estate tax, deferring tax payments often makes financial sense.

Gifting vs. Inheriting
Does it ever make sense to gift appreciated assets during your lifetime? From a personal perspective, there’s joy in giving “with a warm hand” rather than a “cold one.”

From a tax standpoint, gifting makes sense for estates subject to state-level estate taxes. Lifetime gifts bypass these estate taxes. However, the downside is that beneficiaries receive a “carry-over” basis, meaning they’ll later pay capital gains tax based on the original purchase price. For assets unlikely to be sold anytime soon, gifting is a wise strategy for estates valued above $5 million in states like DC or Maryland.

Evan J. Krame