For example, if you die with an estate valued at $4,000,000 (including a house valued at $1,500,000), then the Massachusetts estate tax owed would be $180,800. To reduce the estate tax, you could gift the house to your child. Your taxable estate would then be $2,500,000, and the Massachusetts estate tax would be $39,200, resulting in a tax savings of $141,600.

Initially, this strategy seems to make a lot of sense. However, you ignored the capital gains tax. Let’s assume you bought the home 40 years ago for $30,000, which will be your cost basis for capital gain purposes. When a donor makes a gift, his or her cost basis in the property is transferred to the donee. Thus, the child’s cost basis in the property will also be $30,000. If your child sells the property shortly after your death, your child will have a capital gain of $1,470,000. The federal capital gains tax (15%) on $1,470,000 will be $220,500, and the Massachusetts capital gains tax (5%) will be $73,500, for a total of $294,000.

By gifting the house, your child lost the opportunity to step up its cost basis. Generally, any asset included in a decedent’s taxable estate gets stepped up to its fair market value on the decedent’s date of death.

Instead, if you retained ownership of the house at death, your child’s cost basis would be stepped up to $1,500,000. Consequently, your child will owe little to no capital gains tax upon sale of the property upon your death.

Here, the most tax efficient approach would be to hold onto the house until your death and pay the additional Massachusetts estate tax. However, if your child has no intention of selling the property, then avoiding the Massachusetts estate tax may be more beneficial.

Before gifting any asset to reduce the Massachusetts estate tax, it is important to consult your estate planning attorney to analyze all tax ramifications to ensure you make the right call.