When it comes to giving, most of us think of passing assets down to children or grandchildren. But what if flipping that tradition on its head—by giving assets upstream, to a parent or older relative—could save your family tens of thousands of dollars in taxes?
Welcome to the world of upstream gifting: a smart, lesser-known tax strategy that can help families reduce or even eliminate capital gains taxes on highly appreciated assets. While the idea may sound counterintuitive, the concept is surprisingly simple. Let’s explore how it works and walk through a real-life example to bring it to life.
Upstream Gifting
Upstream gifting involves transferring an appreciated asset—such as a stock, business interest, or real estate property—to an older family member (usually a parent or grandparent) who then leaves the asset back to the original giver through their estate. When the older person passes away, the asset receives a step-up in basis—a valuable tax reset that eliminates any unrealized capital gains.
In plain English: if you own an investment that has grown significantly in value, giving it to your parent and inheriting it back after their passing could wipe out the tax bill you’d otherwise owe if you sold it yourself.
Stepping-Up
To understand the value of upstream gifting, we first need to talk about the step-up in basis.
When someone dies and leaves assets to heirs, those assets generally receive a “step-up” in tax basis—meaning the cost basis (what you originally paid for the asset) resets to its fair market value on the date of death. If the asset is later sold, capital gains taxes are calculated only on any new appreciation beyond that stepped-up value.
That step-up can erase a large unrealized gain—and the hefty tax bill that would come with it.
Let’s say Sarah acquired 500 shares of a tech company 20 years ago for $20,000. Today, those shares are worth $2,000,000—a $1,980,000 gain. If Sarah sells them herself, she’ll owe capital gains tax. Assuming a 20% federal capital gains rate, she could be looking at a tax bill of nearly $400,000.
But Sarah’s dad, Jim, is 84 years old. Jim doesn’t have a large estate, and his estate value is well below the federal estate tax exemption. Sarah decides to gift the shares to her father.
Now, when Jim passes away, and Sarah inherits the shares back through his trust, the basis is stepped up to the value on Jim’s date of death—say, $3,000,000. If Sarah then sells the shares for that same value, there is no capital gain at all and no capital gains tax.
Sarah and her family just saved $400,000 in taxes by moving the shares upstream and back again.
Considerations
Of course, upstream gifting isn’t right for everyone, and the strategy requires careful planning. Here are a few key points to keep in mind:
Health and Timing: The strategy only works if the recipient passes away after receiving the gift and still owns it at death. If they sell the asset the benefits will be negated.
Estate Size: If the recipient’s estate is large enough to trigger estate tax, gifting valuable assets into their estate might not make sense. But for most people, this isn’t a concern. Today more than $13 million per person is exempt from federal estate taxes.
Trust and Control: You’re giving away legal ownership of the asset. Choose a recipient you trust and plan carefully, possibly using an agreement or trust to guide how the asset is handled.
Medicaid Look-Back: Gifts made within five years of applying for Medicaid long-term care coverage can cause issues. If the parent might need Medicaid soon, proceed with caution.
Final Thoughts
Upstream gifting may feel like a twist on the traditional family dynamic. When done properly, it’s a powerful way to help your family keep more of what you’ve worked hard to build.
Any strategy like this is best started from your financial life plan to get an idea of how your spending and wealth will likely evolve over time. Only then should complex gifting and estate strategies be analyzed.
By understanding your financial life plan and how tax and estate strategies may enhance it, you can unlock surprising opportunities for tax savings. And if the idea of giving assets to your parents sounds odd, just remember that sometimes the smartest strategies start by looking in the opposite direction. As the saying goes, different isn’t always better, but better is always different.
