Step-Up in Basis: The Estate Exit, and Why “Swap Till You Drop” Depends on Current Law

How the step-up works

Basis is what the tax system thinks you paid. Sell for more than basis and the difference is gain; depreciate a rental for years and your basis falls while a recapture bill accrues. Section 1014 interrupts all of it: property acquired from a decedent generally takes a new basis equal to its fair market value at the date of death.¹

The consequences are blunt. The deferred capital gain — gone, for income tax purposes. The depreciation recapture that followed the property through every exchange — generally gone with it. The heirs who sell at the date-of-death value may owe little or no income tax on the sale, and depreciation begins again from the stepped-up basis if they keep renting it.

Note what the step-up is not: it is not an estate tax shelter. The property’s full value still counts in the estate, and estates above the inflation-adjusted federal exemption may owe estate tax — a separate system with its own planning.³

“Swap till you drop,” spelled out

The phrase compresses a three-part strategy:

• Swap: each time a property has served its purpose, exchange rather than sell — deferring gain and recapture under §1031.²
• Till: keep the chain unbroken. Any taxable sale along the way crystallizes everything deferred to that point.
• Drop: hold at death. The step-up resets basis for the heirs, and the deferred ledger generally clears.¹

Said honestly: this is deferral played for permanence, and under current law it works. The strategy’s integrity depends on two statutes staying roughly as they are — which is why the risk section below is not boilerplate.

Where DSTs and 721s fit

DSTs solve the last-decade problem. The investor who should hold until death is often the investor least interested in managing property until death. Exchanging into Delaware Statutory Trusts may let the chain continue — professionally managed, passively held — while the step-up clock runs. Each DST exit is a fresh exchange decision, which we cover in DST Exit Strategies.

A 721 can be the final parking place. Operating partnership units received in a 721 conversion generally also receive a step-up at death under current law — so an investor who accepts a 721, gives up future exchanges, and holds the units to death may still reach the same endpoint, with the REIT handling the real estate in the meantime. The trade-offs — redemption limits, loss of exchange optionality — are covered in The 721 Exit, Honestly.

Qualified investors may be able to use these structures to pursue the estate exit; not all investors will be able to utilize these benefits, and suitability depends on circumstances well beyond taxes.

Married couples and state law

How much of the basis steps up at the first spouse’s death depends on how the property is owned and where:

Community property states — California among them — generally allow a full step-up of both halves of community property at the first spouse’s death, a result commonly called the “double step-up.”¹

Common-law states generally step up only the decedent’s share; the survivor’s half keeps its old basis.

Title, trust structure, and state of residence all move this outcome, and retitling decisions have consequences beyond taxes. This is squarely estate-attorney territory — raise it there, with your basis records in hand.

A worked example

Hypothetical illustration — figures are invented to show the mechanics, not projections or advice

An investor bought a rental decades ago for $200,000, exchanged twice along the way, and now holds DST interests worth $1.4 million carrying roughly $900,000 of deferred gain and recapture. Two endings:

• Sold the year before death: the deferred $900,000 is recognized — capital gains plus recapture, federal and state. The heirs inherit what remains after the tax bill.
• Held at death: the heirs receive the interests with basis stepped to $1.4 million. Sold at that value, the income-tax bill on the deferred gain is generally zero under current law.¹ Whether any estate tax applies depends on the total estate against the exemption.³

The difference between the endings is not investment skill. It is sequencing — which is the whole argument for planning the last decade deliberately.

The honest risk list

• Legislative risk, first and loudest. Proposals to limit 1031 exchanges, cap deferral, or curtail step-up at death have surfaced repeatedly in budget and reform debates. None has passed in that form as of this writing — but a strategy whose payoff arrives at death gives Congress decades of chances to rewrite the ending. Tax laws are subject to change and future legislation could affect the availability or benefits of Section 1031 exchanges and basis step-up provisions.
• Illiquidity until the end. The strategy asks you to stay invested, in illiquid vehicles, for life. Health costs, family needs, and simple changes of mind all collide with that design, and interim sales crystallize the deferred tax.
• Estate tax is its own system. A step-up that erases income tax does nothing about an estate over the exemption — and exemption levels are themselves legislation.³
• Heirs inherit investments, not cash. DST interests and OP units pass as what they are; the heirs’ liquidity depends on exits and redemption programs they do not control.
• Principal risk never leaves. Deferral protects nothing about value. The investments may lose money, and a smaller number stepping up is still a smaller number.

Contact our team to discuss whether these strategies may be appropriate for your circumstances.

Frequently asked questions

Does the step-up apply to DST interests and OP units?

Under current law, property acquired from a decedent generally receives a date-of-death basis, and that treatment generally reaches these interests. Specific structures vary — confirm with your estate attorney and CPA.¹

Does depreciation recapture really disappear at death?

Generally yes — the heir’s new basis is the date-of-death value, and the decedent’s depreciation history does not carry over. It is one of the largest quiet effects of §1014.¹

Is there a holding period before heirs can sell?

No income-tax holding period is required for the stepped-up basis; gains after death are measured from the new basis. Practical liquidity for DST or OP interests is a separate question.

What if my estate is above the federal exemption?

Estate tax may apply to the excess regardless of the income-tax step-up. That is a planning conversation of its own, and the exemption level is set by statute and adjusts over time.³

Could Congress really end this?

Both §1031 limits and step-up changes have been proposed before and not enacted in that form. The honest statement is: the strategy works under current law, and no one can promise you the law of the year you die.

Should I hold a bad investment just for the step-up?

That is the trap in the strategy — tax tails wagging investment dogs. The step-up rewards holding; it does not make every hold wise. Run the investment case first.

Sources & disclosures

1. 26 U.S.C. §1014 — basis of property acquired from a decedent; §1014(b)(6) — community property treatment.
2. 26 U.S.C. §1031 — nonrecognition of gain on like-kind exchanges of real property.
3. 26 U.S.C. §2010 — the unified estate tax credit and its inflation-adjusted exemption.
4. 26 U.S.C. §721(a) — nonrecognition on contribution of property to a partnership.

This guide is educational and is not tax or legal advice; consult your own tax and legal advisors about your specific situation. Qualified investors seeking to defer taxes through Section 1031 or Section 721 transactions may be able to do so under current law; not all investors will be able to utilize these benefits. Tax laws are subject to change and future legislation could affect the availability or benefits of Section 1031 exchanges and basis step-up provisions. Section 1031 exchanges defer — they do not eliminate — capital gains and depreciation recapture taxes. Investments discussed may be speculative, illiquid, and involve a high degree of risk, including the possible loss of principal. Such investments are generally available only to qualified or accredited investors. Securities are offered through Realta Equities, Inc., Member FINRA/SIPC, and investment advisory services are offered through Realta Investment Advisors, Inc., co-located at 1201 N. Orange Street, Suite 729, Wilmington, DE 19801. Neither Realta Equities, Inc. nor Realta Investment Advisors, Inc. is affiliated with Carmona Wealth.