The Step-Up, and Why It Dominates Everything Else
When you die owning appreciated real estate, the tax code resets its cost basis to fair market value on the date of death. Every dollar of appreciation that accrued during your lifetime simply disappears for capital gains purposes. Your heirs can sell the next month and owe essentially nothing.
For a long-term New Jersey investor, this is enormous. Depreciation you claimed over decades has driven your basis down while values went up, meaning the built-in gain on a property held since the 1990s can approach its entire current value. The step-up erases all of it, including the depreciation recapture that would otherwise be taxed at a higher rate than ordinary capital gains.
A two-family purchased in 1996 for $145,000. After thirty years of depreciation, the adjusted basis is roughly $60,000. Today it's worth $620,000.
Sold during your life: roughly $560,000 of gain, including depreciation recapture taxed at up to 25% federally, plus capital gains and New Jersey income tax on the rest. The combined bill can comfortably exceed $150,000.
Held until death: the basis steps up to $620,000. Your heirs sell shortly after and owe essentially nothing on the appreciation. The entire liability evaporates.
The Advice That Destroys It
Here is the most common and most expensive mistake we see New Jersey investors make: deeding property to their children during life. It gets recommended constantly — to avoid probate, to "get it out of my name," to simplify things — and it is almost always the wrong tool.
A lifetime gift of real estate carries over your basis. Your children take the property with your $60,000 basis and the entire built-in gain intact. The step-up they would have received at your death is gone permanently. On the example above, that single deed costs the family well over $100,000 in tax that a different structure would have avoided entirely.
It also creates problems beyond taxes. The property becomes your child's asset — exposed to their divorce, their creditors, their bankruptcy, and their own estate plan if they predecease you. You need their signature (and often their spouse's) to sell or refinance. And if the goal was Medicaid protection, the gift starts a five-year clock and creates a penalty period without solving anything the right structure wouldn't have solved better.
Get a second opinion before recording anything. Probate avoidance, control, creditor protection, and Medicaid planning are all achievable — through structures that preserve the step-up. Adding children to a deed accomplishes them poorly while giving up the single most valuable tax feature your portfolio has.
Probate: The Problem Deeding Was Meant to Solve
Real estate held in your individual name passes through probate. In New Jersey that's a more manageable process than in many states, but for an investor it still means delay, public filing, court involvement in the transfer of each property, and complications if you own property in more than one state — where a second, ancillary probate may be required.
The clean solutions preserve the step-up: holding property through a revocable trust, holding LLC interests that pass under a trust or through properly drafted transfer provisions, or in some cases a beneficiary designation structure. Each avoids probate without triggering a lifetime transfer. See holding rental property in a trust for how these compare.
New Jersey Inheritance Tax: Who Inherits Changes Everything
New Jersey repealed its estate tax, so most investors owe no state estate tax at death. But the inheritance tax remains, and it turns on the beneficiary's relationship to you:
- Class A — exempt. Spouses, civil union partners, children, grandchildren, parents, stepchildren.
- Class C — 11–16% above a $25,000 exemption. Siblings, sons- and daughters-in-law.
- Class D — 15–16% from nearly the first dollar. Nieces, nephews, cousins, friends, unmarried partners.
For an investor planning to leave properties to a nephew who helps run them, or to a longtime unmarried partner, this is a first-order planning issue rather than a footnote. A $600,000 building passing to a Class D beneficiary carries roughly $90,000 of New Jersey inheritance tax — and the tax is due before the estate fully settles, which for an illiquid real estate estate creates a genuine cash problem.
The Liquidity Problem
Real estate estates are cash-poor by nature. Inheritance tax, final expenses, mortgage payments that don't stop, property taxes, and insurance all come due while the estate is being administered — and the assets are buildings, not bank accounts. Families routinely discover this the hard way and sell a property under time pressure at a discount.
Planning for it is straightforward once the problem is visible: life insurance sized to the expected liability, a reserve account, or provisions authorizing the executor to borrow against the properties rather than sell. Which one fits depends on the portfolio, but doing nothing is the option that produces the forced sale.
Frequently Asked Questions
The LLC interest you own receives a step-up in basis at death. Whether that inside basis of the property itself adjusts depends on the entity's tax classification and whether certain elections are in place — a partnership-taxed LLC may need a Section 754 election for the inside basis to follow. This is a detail worth confirming rather than assuming, because it's the difference between the step-up working as expected and only working partway.
That's a legitimate goal and there are structures for it — gifting LLC interests over time rather than deeding real estate, sales to intentionally defective grantor trusts, or simply transferring cash from operations rather than the underlying asset. What they share is that they don't hand away the step-up on the appreciated property itself. The goal is achievable; the deed is just the wrong instrument.
Yes — out-of-state real estate held individually generally requires ancillary probate in that state, which means a second court process, second set of fees, and second timeline. Holding out-of-state property through an entity or trust is the standard fix, and it's one of the clearer cases where restructuring pays for itself.
A life estate deed preserves a step-up on the retained interest and avoids probate, which is why it gets recommended. But it gives up control — you generally can't sell or refinance without the remaindermen's cooperation — and it exposes the remainder interest to your children's creditors and divorces immediately. For investment property specifically, an entity-and-trust structure usually accomplishes more with fewer tradeoffs.