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Investor WorkspaceA little clarity for your next decision.
By Jerry Baker
A 1031 exchange can defer gain while you own investment real estate, and qualifying property inherited at your death generally receives a new income-tax basis tied to its value. These are separate tax rules, with exceptions that make ownership, trusts, and the timing of a sale important. This guide explains how they can work together and what your family should check before relying on that result.
A successful exchange moves deferred gain into replacement real estate. It does not normally give you a fresh basis equal to the property's full purchase price. That lower basis can matter when you later sell, take depreciation, or plan another exchange. Section 1031 supplies the exchange rules; Section 1014 supplies the general basis rule for property acquired from someone who has died. [1] [2]
You may hear this described as exchanging until death. The phrase captures a possible path, but it skips important questions. Did the owner still hold qualifying property? Who owned it for tax purposes? Had a sale already created taxable income? Was the asset moved into a trust during life? A family needs those answers before calling deferred gain eliminated.
Nor does tax law make the investment safe. A building can lose value, a loan can mature, and a private investment can stay illiquid. I would keep the investment decision and the estate decision on the same page. Saving a possible future tax should not hide a weak property, a poor fit, or an immediate need for cash.
Basis is the tax amount used to measure gain or loss. An owner's adjusted basis may reflect earlier exchanges, improvements, and depreciation. Under the general death-time rule, qualifying inherited property takes a basis equal to fair market value at death. Alternate valuation, special-use valuation, and other specific rules can change that result. [2] [3]
The familiar term “step-up” assumes value has risen above basis. The rule can also produce a step-down. If qualifying property has a $900,000 adjusted basis but is worth $750,000 at death, the general new basis is $750,000. The family cannot keep the larger number just because it gives a better result on a later sale.
A new basis changes the calculation for income tax. It does not add cash to a bank account, cancel the property's loan, or waive estate taxes. It also does not lock in the property's value. Heirs can earn more income, face more costs, and realize new gains or losses after death.
Ask for two separate schedules: the property's basis before death and the basis that applies afterward. Keep the support for both. A final return may still need the first schedule, while the estate and heirs may need the second. The transition is a recordkeeping task as well as a tax event.
Consider this hypothetical rental property. It is owned directly by one person and passes to an heir under the general Section 1014 rule. Assume a valid date-of-death value, no special valuation election, and no exception. The figures are examples, not a forecast or an appraisal.
The inherited property's basis is generally $1,800,000 in these facts. It is not limited to the $1,200,000 of net equity. Property value and cash left after paying a lender measure different things. The debt remains part of the family's financial picture, even though it does not reduce this property's date-of-death basis to net equity. [2]
Suppose the heir soon sells for $1,850,000 and has $50,000 of selling costs that properly reduce the amount realized. Assume no basis changes after death. The amount realized is $1,800,000. Subtracting the $1,800,000 basis leaves no gain in this simplified calculation. Paying the $600,000 loan leaves $1,200,000 of cash after those sale costs. [4]
Before death, that same $1,800,000 net amount realized against a $400,000 basis would imply $1,400,000 of gain. The comparison shows why the basis rule matters. It does not show that every estate owes no tax or that every sale after death produces no gain. A different valuation, sale date, expense, or ownership structure changes the analysis.
What happens if the heir keeps renting the property? Rent does not become tax-free because the building was inherited. The heir must account for income, expenses, and the depreciation rules that apply to the inherited property. The land and depreciable portions need support; land is not depreciated. [3] [4]
For example, suppose later basis reductions total $100,000 and no other adjustments occur. A starting basis of $1,800,000 becomes $1,700,000. A later sale with a $1,900,000 amount realized would create $200,000 of gain before further tax analysis. Part of the gain may need separate treatment because of depreciation. A basis adjustment at death does not shelter all future growth.
The heir might consider a new 1031 exchange if the property is held for business or investment and the exchange meets the rules. That is a new decision with new facts. The prior owner's exchange history does not automatically qualify the heir's next transaction. A property used as the heir's personal home raises different issues. [1]
The original purchase price may be easy to find. A current fair market value may be harder, especially for a private real estate interest. Do not assume the amount shown on an old statement, the initial offering price, or the remaining loan balance supplies the right basis value.
The estate's tax team should determine the relevant valuation date and the property interest being valued. A whole building and a fractional interest are not necessarily the same valuation assignment. Restrictions, debt terms, and the actual ownership rights may need analysis. Any discount needs a sound basis; it is not a standard percentage to choose from a website.
Section 1014 also has a basis-consistency rule for covered property. Its scope includes an estate-tax condition; it is not a claim that every heir must receive the same reporting form. The executor and CPA should decide which estate and beneficiary reporting rules apply and keep the valuation records aligned. [2]
A practical file includes the appraisal, ownership documents, loan statement, prior basis schedule, and any estate value reported to the IRS. If a value changes during estate administration, tell the person preparing the heir's returns. Using two incompatible values in two separate files creates avoidable problems.
Giving property to a child during life generally does not create the same basis result as a qualifying inheritance. Section 1015 generally carries the donor's basis into a gift, with special rules for loss and possible gift-tax adjustments. The recipient needs the donor's records, not just the property's market value on the gift date. [5]
Suppose a parent gives an adult child debt-free investment land worth $900,000 with a $200,000 adjusted basis. Ignoring gift-tax basis adjustments and other special facts, the child's basis for gain generally remains $200,000. A later $900,000 sale is not treated as having no gain merely because the land was worth that much when given.
That does not make gifts a bad planning tool. A gift may serve family or estate goals that matter more than basis. It means the plan should compare both effects. An estate-tax strategy and an income-tax strategy can pull in different directions. The attorney and CPA should model the whole transfer before title changes.
There is also a targeted anti-abuse rule. Appreciated property given to someone within the one-year period ending at that person's death can lose the usual step-up if it passes back to the donor or the donor's spouse. A related rule addresses certain sale proceeds passing back. Sending property through another person's estate is not a dependable basis shortcut. [2]
A revocable living trust and an irrevocable trust can have very different tax effects. Income-tax ownership, gift-tax treatment, and estate inclusion are separate tests. Saying that a trust is a “grantor trust” answers an income-tax question; it does not by itself prove a death-time basis adjustment.
Revenue Ruling 2023-2 addresses that distinction. In its facts, an owner made a completed gift to an irrevocable trust. The owner was still treated as owning the trust for income-tax purposes, but its assets were outside the owner's gross estate and did not meet another covered Section 1014 category. The ruling found no basis adjustment at death. [6]
Do not extend that holding to say no trust can receive a basis adjustment. Section 1014 expressly covers several ways property can pass through trusts or be included at death. The right question is which rule applies to this trust, these retained powers, and this asset. [2]
Before moving exchange property or a DST interest into a trust, coordinate the trust review with the investment documents. A legally permitted transfer and a desired tax result are separate matters. Keep a written explanation of who will report income now and how basis should be determined later.
A surviving spouse does not always receive a full reset on every jointly held asset. For a typical qualified joint interest, the inherited portion and the survivor's existing portion can have different basis treatment. The IRS gives separate instructions for calculating those parts. Nonspouse joint ownership can require a different analysis. [3]
Community property has a special rule. Section 1014(b)(6) can adjust the survivor's half as well as the deceased spouse's half when its conditions are met, including the required estate inclusion. Living in a community-property state does not prove that every asset the couple owns is community property. Title and the property's history matter. [2]
Ask the estate lawyer to identify the ownership category before the CPA calculates basis. A change in title made years ago, a separate-property agreement, or a prior gift can matter. Keep that review tied to the actual property, rather than applying one assumption to the family's entire portfolio.
An inherited partnership interest raises a different issue from inheriting a building directly. “Outside basis” means the owner's basis in the partnership interest. “Inside basis” means the partnership's basis in its assets. A change to one does not automatically reset the other for everyone. [7]
Section 743 generally does not adjust partnership property merely because a partner dies. An adjustment can apply when a Section 754 election is in effect or the substantial built-in-loss rule requires it. A Section 743(b) adjustment is specific to the new partner and must be allocated under the governing rules. [7]
Here is a simplified, debt-free example. Assume an heir's basis in an inherited interest is $1,000,000. The heir's share of the partnership's adjusted asset basis is $300,000. If the needed election and rules apply, the difference points to a $700,000 special adjustment for that heir. It is not a $700,000 increase for every partner.
Real calculations may include liabilities, prior contributions, and other allocations. Send the death and valuation information to the partnership's tax preparer promptly. Ask who will track the special adjustment and whether a timely election is needed. An heir's personal CPA cannot safely assume the partnership has already handled it.
A Delaware statutory trust is not a special estate-tax exemption. Revenue Ruling 2004-86 treats the owners in its carefully limited arrangement as holding interests in the underlying real property for federal income-tax purposes. That treatment supports a separate review of basis at death; it is not proof that every entity with “DST” in its name works the same way. [8]
For an actual investment, identify its current tax classification and the rights being transferred. A later restructuring or contribution into a partnership may change what the investor owns. The estate team should use the documents in effect at death, not rely only on the structure shown when the investment was first purchased.
Death also does not promise an early exit. A private offering may restrict transfers and provide little or no market for resale. Heirs may need to submit estate papers, tax information, and other required documents while the underlying investment continues. Review those terms before treating a DST as cash available to divide among family members. [9]
Section 1014(c) excludes income in respect of a decedent, often shortened to IRD. Broadly, this involves income the deceased person was entitled to receive that was not properly included on the person's final or earlier income-tax return. Section 691 governs how recipients report it. The income's character generally carries through. [2] [10]
An installment sale illustrates the difference. If the owner already sold the building and died holding the buyer's installment obligation, the remaining deferred profit does not simply disappear through a step-up. IRS guidance tells the recipient to use the deceased seller's gross-profit percentage to determine the profit portion of later payments. [3]
A completed taxable sale before death is also different from owning the real estate at death. Inheriting sale proceeds does not undo gain already realized by the seller. If a sale is under contract but has not closed, the legal and tax facts need careful review. Do not assume the closing date alone resolves every income-right question.
The federal basic estate and gift tax exclusion is $15 million for 2026 under the law enacted in 2025. The statute provides inflation adjustments after 2026. Earlier material forecasting a return to a much lower 2026 exclusion does not reflect that enacted change. Prior taxable gifts and other estate facts still matter. [11]
A surviving spouse may be able to use a deceased spouse's unused exclusion, but portability requires the proper return and election. Do not assume a married couple automatically has a combined unused amount without reviewing prior gifts, prior spouses, and filings. Nor does a federal exclusion answer whether a state estate or inheritance tax applies.
An estate can qualify for a basis adjustment without owing federal estate tax. Conversely, receiving a higher income-tax basis does not prove the estate owes nothing. Keep the basis calculation, estate-tax calculation, and need for cash separate. An illiquid asset may still need reserves for debt, expenses, and estate administration.
Start with a list of assets, owners, loans, and tax classifications. Mark which properties came through exchanges and where the related forms are stored. Include the current governing documents for private interests and the contact responsible for ownership changes. That lets the estate team ask useful questions without rebuilding decades of history. Give the executor a clear way to locate those files. A folder that only the owner knows how to access may be little help when the family needs it most.
Next, compare the family's choices. Does someone want to manage the real estate? Could the estate cover costs without a rushed sale? Would equal shares of an illiquid investment match each heir's needs? A mathematically equal division may leave one person comfortable and another short of cash.
Finally, review the plan as facts change. A new loan, marriage, divorce, trust amendment, investment restructuring, or change in tax law can affect it. I would use the potential basis benefit as one input in that review. The goal is an understandable plan that supports the family, not a slogan that assumes every future event will cooperate.
No. Section 1031 generally defers gain through basis. Section 1014 is the separate rule that can change basis when qualifying property passes at death. Ownership, trusts, income rights, and exceptions determine the result. [1] [2]
For qualifying directly owned property under the general rule, basis is tied to the property's fair market value, not simply cash equity after debt. Partnership interests and fractional interests need their own valuation and basis work. [2] [7]
Yes. The general rule uses value, even when value is below the deceased owner's adjusted basis. “Step-up” is common shorthand, but a step-down is possible. Special valuation rules can also affect the amount. [2]
No. Income-tax ownership alone does not establish the result. Revenue Ruling 2023-2 found no adjustment for the completed-gift irrevocable trust in its facts. Other trusts may meet a covered Section 1014 category. [6]
Not automatically. First determine basis and the tax cost of a sale. A later exchange is a separate choice that depends on eligible property, investment purpose, and the exchange requirements. Compare it with the heirs' cash and ownership needs. [1]
Generally not for gain. Gift basis usually carries over, with special loss and gift-tax adjustment rules. An inheritance and a lifetime gift should be compared before the transfer, not assumed to have the same result. [5]
Generally, the remaining profit is income in respect of a decedent. The recipient reports the profit component under the applicable installment rules. Inheriting the note is different from inheriting the unsold real estate. [3] [10]
No. Basis affects income tax. Federal transfer taxes and any relevant state taxes need separate review. The 2026 federal basic exclusion and a possible portability election do not establish that every family's estate is tax-free. [11]
Educational information, not an offer or a personal tax, legal, or investment recommendation. Examples are hypothetical and omit stated adjustments. Tax treatment depends on your facts and current law. Review your transaction with your CPA, attorney, and qualified intermediary. Real estate investments can lose value and may be illiquid.
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