Lady Bird Deeds and Capital Gains: Why the Beneficiary Gets a Stepped-Up Basis

Henry's House: The Numbers That Worry Every Florida Family

Henry is 84 and lives in Winter Park in the house he bought back in 1985 for $40,000. Today it's worth something in the neighborhood of $600,000. He is a composite example I use to illustrate a question I hear constantly, not an actual client, but the math is the kind I walk through with real families every week.

A lady bird deed, also called an enhanced life estate deed, lets Henry keep full control of the house for the rest of his life. He can sell it, mortgage it, or change his mind and revoke the deed entirely. When he dies, the house passes directly to whoever he named, without going through probate. What people really want to know is what happens on the tax side once that transfer occurs. That is the question this article answers.

The Difference Between a Gift Now and an Inheritance Later

If Henry simply signed a deed today giving the house outright to his kids as a lifetime gift, the tax code would treat that as a carryover basis situation. His children would step into his shoes for tax purposes, inheriting his original $40,000 basis (adjusted for any capital improvements over the years). If they later sold the house for $600,000, they would be looking at capital gains tax on roughly $560,000 of appreciation, minus whatever adjustments applied.

A lady bird deed works completely differently, because Henry is not giving up ownership during his life. He keeps a retained interest, sometimes called an enhanced life estate, and the house only passes to his beneficiaries at his death. Because Henry retained the right to use, control, and even sell or revoke the property during his lifetime, the house is treated as part of his estate for tax basis purposes when he dies. That distinction is what triggers a stepped-up basis instead of a carryover basis.

What Happens When Henry's Beneficiaries Inherit and Sell

When Henry passes away, his children's basis in the house resets to its fair market value on his date of death, not the $40,000 he originally paid. If the house is worth about $600,000 at that point, their new basis is roughly $600,000.

Suppose they sell the house about a year later, once Florida property values have ticked up slightly, for $620,000. Their taxable gain is not $580,000 (the difference from Henry's original purchase price). It is closer to $20,000, the appreciation that occurred after Henry's death. That is the entire benefit of the step-up in a single sentence: the decades of appreciation that built up while Henry owned the home simply disappear from the tax calculation.

Compare that to the lifetime gift scenario from the prior section, where the same $580,000-plus gain would have been fully exposed to capital gains tax. The dollar difference between those two paths is the reason so many Florida families use a lady bird deed instead of deeding the house away while the parent is still living.

If a Beneficiary Moves In: The Primary Residence Exclusion

Sometimes an adult child inherits the house and decides to live in it rather than sell it right away. If that beneficiary later sells after living there as their primary residence for the required period, they may also be able to use the federal home sale exclusion that lets homeowners exclude a substantial amount of gain on the sale of a primary residence. That exclusion is separate from the stepped-up basis, but the two work together. The step-up already wipes out the gain that built up during the original owner's lifetime, and the residence exclusion can shelter some or all of whatever additional appreciation happens after that, if the beneficiary occupies the home as their own primary residence for long enough to qualify.

This is a fact-specific question that depends on how long the beneficiary lives there and how the sale is structured, so it deserves individual review rather than a blanket assumption.

Does Henry's Estate Owe Any Tax at All?

Here is where I put a lot of Florida families at ease. Florida has no state estate tax and no state income tax, so neither Henry's estate nor his beneficiaries owe the state of Florida anything on this transaction. On the federal side, a house is included in the deceased owner's gross estate when they retained a life estate interest in it, which is exactly what a lady bird deed does. But federal estate tax only applies once an estate's total value climbs well past what the overwhelming majority of Florida homeowners ever accumulate. For a house like Henry's, worth around $600,000, federal estate tax simply is not in the picture.

What This Meant for Henry

Coming back to Henry: because he used a lady bird deed rather than gifting the Winter Park house outright, his children inherit the home with a basis reset to its value on the date of his death rather than his 1985 purchase price. If they sell soon after, most of the capital gains tax that would otherwise apply simply does not exist. The house also passes to them without probate, and Henry never lost the ability to sell it, refinance it, or change his beneficiaries while he was alive.

Florida has no statute that specifically creates the lady bird deed. It rests on long-standing common law principles, Florida title standards, and decades of consistent use and recognition by title companies and the courts. A properly executed Florida deed still needs two witnesses and a notary, and it must be recorded in the county where the property sits. Truestead prepares Florida lady bird deeds starting at $199 for a self-guided version or $399 for an attorney-prepared deed that includes recording.

This article is for general informational purposes only and does not constitute legal advice, nor does reading it create an attorney-client relationship. Florida estate, elder, probate, and real estate law are fact-specific and change over time. Consult a licensed Florida attorney about your individual circumstances. Arthur Simpson, Esq. is licensed to practice law in the State of Florida. Attorney advertising.