For most Americans, estate planning involves determining how to transfer your accumulated wealth to the younger generation, either through annual gifts or through your estate (or living trust if you want to avoid probate).  But some tax professionals are recommending that some of their clients’ gift assets to their parents in some more niche cases.

What?  The point of the exercise involves what’s called the step-up in basis, a fancy term for removing capital gains tax obligations from an asset that has grown in value.  

If you sell an asset for more than you paid, you owe taxes on the difference—right?  If you own the (stock, mutual fund, etc.) for more than a year, then you will pay at the capital gains rate; otherwise, the gain is taxed at your tax rate, as ordinary income.  

But (here’s the key) if you die owning the asset, and it passes on to your heirs, then they receive the (stock, mutual fund, etc.) at the current market price—and presto!  If they sell it tomorrow (assuming no changes in value), there will be no gain to report, and no tax obligation.  The ‘step-up’ is the fact that the low purchase price is now reset to the current market value, making the taxable capital gains evaporate.

Many people are holding assets that are worth more than they paid for them, so this step-up at death can be a valuable part of estate planning.  The general advice Tax professionals give is that if there are gains and you do not need the money, then it is typically beneficial to keep the extremely profitable investment until you die and give a nice tax break to your heirs.

But what if you gift that profitable investment to your parents, who are probably closer to death than you are?  They receive it, and when they die, they pass it back on to you as the heir—with the step-up in basis.  You can then sell that holding with no capital gains obligation.

Of course this can get extremely complicated, and whether this is even feasible or possible for some estates is often not so straightforward.  If you are just one of several of your parents’ heirs, it is possible that the stock you gift ‘upstream’ will get passed on to someone else for example (of course your parents can write the will such that this won’t happen though).  The parents could also even leave the appreciated asset to your children instead of you, bypassing a generation.

With all of this, there is a catch; your parents would need to live for at least three years after you gift whatever assets you chose to them.  Otherwise, the asset(s) will revert to you.  This is not a ‘deathbed planning’ opportunity.

This article was written by an independent writer for Brewster Financial Planning LLC and is not intended as individualized legal or investment advice.