Why It Matters
You probably won't owe a dollar of federal estate tax — the exclusion is $13.99 million per person in 2025, $27.98 million per married couple with portability. But that's not the whole story.
Twelve states and Washington D.C. have their own estate taxes with far lower thresholds. Oregon hits at $1 million. Massachusetts at $2 million. Two rentals plus a primary residence in either state can push you over the line. And the federal exclusion was in flux: the Tax Cuts and Jobs Act nearly doubled it in 2018, but that provision was set to sunset December 31, 2025, cutting it nearly in half without a legislative fix.
The more important question for most investors isn't whether they'll owe the estate tax — it's whether they're using estate planning to maximize the step-up in basis their heirs receive at death. That step-up permanently erases all accumulated capital gains and depreciation recapture on inherited property. For a long-held portfolio with serious embedded gain, that single planning decision is worth more than any current-year tax strategy.
At a Glance
- Federal rate: 40% flat on the taxable estate above the exclusion
- 2025 exclusion: $13,990,000 per person; ~$27.98M per married couple (with portability)
- State taxes: 12 states + D.C. have estate taxes; some start as low as $1M (Oregon)
- Who it hits: Fewer than 0.2% of US estates owe federal estate tax
- The bigger issue: Step-up in basis at death wipes out all capital gains and depreciation recapture on inherited property — the planning opportunity most investors overlook
- Key strategies: Annual gifting, entity structuring with valuation discounts, charitable trusts, holding until death for the step-up
Estate Tax Owed = (Gross Estate − Deductions − Applicable Exclusion Amount) × 40%
How It Works
Calculating the taxable estate. Your gross estate includes everything you own at death: real property at fair market value, bank and investment accounts, retirement accounts, life insurance proceeds (if you own the policy), and business interests. Subtract the deductions — outstanding mortgages, debts, funeral expenses, executor fees, charitable bequests to a charitable remainder trust or direct donation, and the unlimited marital deduction for transfers to a surviving US citizen spouse. What's left is the taxable estate. Subtract the exclusion amount, multiply by 40%, and that's the bill.
Portability is the most missed election in estate planning. When the first spouse dies, the executor must file Form 706 within nine months to transfer any unused exclusion to the surviving spouse — even when no estate tax is owed. Many families skip this filing because the estate is below the threshold. Then the surviving spouse dies years later with a larger estate and discovers they lost $13.99 million in combined exclusion. Sound familiar? It happens constantly in estates without an attorney flagging it.
The step-up in basis is the real prize. When you die owning appreciated property, your heirs inherit at the fair market value on your date of death — not your original purchase price. This is the step-up in basis. A rental you bought for $300,000 with an adjusted basis of $180,000 after depreciation and a current value of $700,000 passes to your heirs at $700,000. All $520,000 of embedded gain — and all accumulated depreciation recapture — disappears permanently. Not deferred. Gone. That's why serious investors hold their best properties rather than sell: it's not inertia, it's strategy.
Gifting and entity discounts reduce the taxable estate. The annual exclusion lets you give $19,000 per recipient per year (2025) without gift tax consequences. For larger estates, entity structuring through a family LLC or limited partnership lets you transfer minority interests at a valuation discount of 15-35% — a $1M rental portfolio held through a family LLC gets valued at roughly $700,000 in the estate, because minority interests in illiquid entities are worth less than their pro-rata share. A Delaware Statutory Trust can let you divide fractional interests among heirs without triggering a sale. But gifting appreciated real estate during your lifetime means the recipient inherits your low adjusted basis — no step-up. For heavily appreciated property, holding until death saves more in taxes than gifting. Almost every time.
Real-World Example
Marcus and Linda built a rental portfolio over 25 years: eight properties worth $4.17 million in aggregate, with $1.63 million in outstanding mortgages. Their net real estate equity is $2.54 million — well under the $13.99M federal exclusion, so no federal estate tax.
But they live in Oregon, where the estate tax starts at $1 million. Add their primary residence ($312,000), retirement accounts ($473,000), and savings/brokerage ($135,000), and the total gross estate hits $5.09 million. After deducting the mortgages and other liabilities, the taxable estate lands at $3.41 million. Oregon taxes the amount above $1 million on a marginal schedule from 10-16%, producing a state estate tax bill of $269,000 — due within nine months of death, in cash. That's a real check. And it comes due while their heirs are still settling the estate.
The properties can't be liquidated quickly without triggering capital gains, so the cash has to come from somewhere. Marcus and Linda respond with two strategies: they restructure two properties into a family LLC where each adult child receives minority interests over time using the annual exclusion, reducing the estate's value through both the gifted interests and a 20% minority interest discount; and they buy a life insurance policy sized to cover the estimated estate tax, owned by an irrevocable trust so the proceeds stay outside the estate.
On the federal side, three of their properties have been held for over 15 years with serious embedded gains. Those don't get sold. Ever. Their heirs will inherit at current fair market value with zero capital gains liability — all the depreciation recapture gone with it.
Pros & Cons
- Step-up in basis at death permanently eliminates all accumulated capital gains and depreciation recapture — the single most powerful tax benefit in long-hold real estate investing
- At $13.99M per person in 2025, the federal exclusion is high enough that your federal estate tax bill is likely zero
- Portability lets married couples effectively double the exclusion with a single Form 706 filing after the first death
- The annual exclusion ($19,000/person/year in 2025) chips away at a taxable estate every year without gift tax consequences
- Entity structuring with LLCs or family limited partnerships can cut the estate's assessed value by 15-35% through minority interest discounts on illiquid holdings
- State estate taxes have far lower thresholds — Oregon's $1M trigger means a modest portfolio can create real exposure
- The tax bill is due in cash within nine months of death, which can force a fire sale of illiquid real estate
- Gifting appreciated property during your lifetime transfers your low adjusted basis — no step-up — creating a bigger capital gains problem for your heirs than the estate tax would have
- The federal exclusion is subject to political change: it was set to revert to roughly $7M at the end of 2025, cutting nearly $7M of coverage until legislation addressed it
- Irrevocable trust strategies require giving up permanent control of the assets — a real tradeoff many investors resist until it's too late
Watch Out
The "step-up vs. gift" tradeoff gets expensive fast. Gifting an appreciated rental to your children seems generous — but they inherit your adjusted basis, not the current value. Give away a property worth $800,000 with a $200,000 basis and your heirs face a potential $600,000 capital gain when they sell. Had you held it until death, they would have inherited at $800,000 and owed nothing. Run the math before gifting any property with real embedded gain.
Portability is a one-shot election with a hard deadline. The executor must file Form 706 within nine months of the first spouse's death. If the estate is below the threshold and nobody thinks to file — which is exactly what happens in most families without an estate attorney — that unused exclusion is gone permanently. Years later, when the surviving spouse's estate has grown, the lost exclusion is worth millions in tax at 40%.
State estate taxes can blindside moderate investors. State thresholds start at $1M in Oregon, $2M in Massachusetts, $2.193M in Washington. The state tax is completely separate from the federal calculation, and state exclusions aren't indexed for inflation or portable between spouses in most cases. If you own rentals in one of these states, you need state-specific planning — the federal analysis alone won't get you there.
When using a Delaware Statutory Trust for estate planning, understand what you're giving up. DST interests can be divided fractionally among heirs without triggering a sale, which is useful. But you lose all operational control over the underlying asset entirely — no refinancing, no repositioning, no sale without the sponsor's decision. Work with an estate attorney specifically on DST structures before using them as a wealth transfer vehicle.
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The Takeaway
The federal estate tax probably won't touch you — the $13.99M per-person exclusion in 2025 sits far above what most portfolios reach. The real exposures are state estate taxes that kick in at $1M, the risk of the federal exclusion dropping if Congress doesn't act, and the strategic question of whether you're holding your best properties until death to maximize the step-up in basis. Hold your most appreciated rentals through death and the IRS permanently wipes all the embedded gain and depreciation recapture. That decision is worth more than almost any tax strategy you run while you're alive. Know your state's rules and get the portability election calendared — those two moves alone can be worth millions to the people you leave behind.