DST Estate Planning and Step-Up in Basis: Benefits, Limits, and Heir Decisions

By Jerry Baker

A qualifying DST interest may receive a new tax basis when its owner dies, which can reduce the gain taxed on a later sale. That result depends on the ownership and inheritance rules, and it does not make a DST tax free, liquid, or safe.

The benefit comes from tax law, not the DST label

A Delaware statutory trust can be part of an estate plan. It may let an owner hold real estate without handling daily property decisions. But the basis rule at death is not a special reward for buying a DST. Section 1014 applies to qualifying property acquired from a person who has died. It can apply to other kinds of property as well. [1]

That matters when you compare choices. A rental building held directly might also qualify for a basis adjustment. Selling that building now and buying a DST does not create a second, separate estate benefit. The choice still needs to account for fees and control. Property quality and the family’s cash needs matter too.

The federal treatment of the DST itself also needs review. Revenue Ruling 2004-86 treats investors as owning shares of the underlying real estate under its stated facts. It does not approve every trust or every future change to an investment’s structure. [2]

I would begin with a plain question: What do you want your family to inherit, and what work will come with it? The tax answer is one part of that discussion. The ability to manage, value, transfer, and later sell the asset matters too.

What tax basis means in an estate plan

Basis is a tax record used to measure gain or loss. Where allowed, it also affects depreciation. It is not the same as current value. It may differ from the cash first invested or the balance on a sponsor statement. Improvements, depreciation, prior exchanges, and other items can change it over time.

A fully deferred 1031 exchange generally carries the old investment’s deferred gain into the replacement property through the basis calculation. Buying a replacement that costs more does not automatically give the taxpayer a fresh basis equal to its full value. Added money, debt, recognized gain, and other adjustments need to be included correctly. [3]

This explains why an investor can have a valuable property interest with a much lower tax basis. Years of depreciation and earlier exchanges may leave large built-in gain. A sale during life can make that gap relevant to the income-tax bill.

Section 1014 addresses a different event: qualifying property passing at death. Its general rule uses fair market value at death. Exceptions and special valuation rules can apply. The new basis can change the gain calculation for the person who receives the property. [1]

A step-up example, without a tax-rate guess

Assume a person owns a qualifying real estate interest with an adjusted basis of $300,000. At death, its properly determined fair market value is $900,000. Assume the full interest qualifies for the general Section 1014 rule, with no special election or exception. Its new basis would be $900,000.

If the heir later has $940,000 of net amount realized on a sale, with no other basis changes, the gain would be $40,000. Using the old $300,000 basis would instead produce $640,000 of gain. The basis adjustment changes the gain calculation by $600,000 in this simplified example. [1] [4]

That $600,000 is not a tax savings figure. It is a difference in gain. A tax estimate would need the actual facts, income character, federal and state rules, other income, and any applicable deductions. The illustration also assumes that “net amount realized” already reflects relevant sale adjustments.

Do not subtract the mortgage twice when working through this math. Cash paid to the family, debt relief, property value, and tax basis are different figures. Have the preparer reconcile them from the closing records and ownership details rather than using a bank deposit as the sale price.

A step-down is possible too

The phrase “step-up” describes only one direction. Suppose the owner’s adjusted basis is $700,000 but the qualifying property is worth $550,000 at death. Under the general fair-market-value rule, the new basis would be $550,000. A later sale with $570,000 of net amount realized and no other changes would produce $20,000 of gain.

The heir does not generally get to keep the higher basis just because it would be more useful. The same statutory valuation rule that can remove old built-in gain can also reduce basis when value has fallen. [1]

This is one reason not to build the estate plan around a promised property appreciation rate. The asset may be worth more, less, or nothing when it passes. A private real estate investment can lose value regardless of the tax treatment of the transfer. [5]

Also remember that a basis adjustment is not a payment. In the step-up example, the family does not receive $600,000 from the government or the sponsor. It receives an asset with a different tax record. Cash still depends on the investment’s distributions, sale, or another lawful source.

How “exchange and hold” differs from a guarantee

An owner may plan to keep real estate during life and leave it to heirs. A series of valid 1031 exchanges can defer gain while the owner continues to meet the rules. If qualifying property is later acquired from that owner at death, Section 1014 may apply. Those are separate legal steps. [1] [3]

Each exchange still needs to work on its own. Cash received, debt changes, ineligible property, missed deadlines, or other problems can create current tax. A future inheritance plan does not repair a failed exchange today.

A DST’s managers may sell its real estate before the investor dies. The next choices then depend on the offering’s terms and the tax rules in effect. An investor cannot assume a property will remain inside the same structure for life or that the next suitable exchange will be available.

Tax law can also change. A plan that makes sense under current rules should be reviewed as circumstances change. Describe the possible benefit with care. A slogan that promises to erase tax forever skips too much.

Trust ownership requires more than one tax label

A revocable living trust may be used in an estate plan, and certain retained rights appear within Section 1014’s categories. But “held in trust” is not a complete tax analysis. The lawyer and preparer should identify which statutory category supports the expected basis treatment. [1]

Grantor trust status concerns who reports income for income-tax purposes. It does not, by itself, establish what happens to basis at death. Some irrevocable trusts are grantor trusts even though their assets are outside the grantor’s gross estate.

Revenue Ruling 2023-2 addresses such an arrangement under specific facts. The owner made a completed gift to an irrevocable trust and retained a power that caused income-tax ownership. The assets were not included in the gross estate and did not meet another applicable Section 1014 category. The IRS held that basis did not change at death. [6]

The lesson is not that every irrevocable trust has the same outcome. It is that these are separate tests. Who pays income tax? Was there a gift? Is the asset in the estate? What basis rule applies? A plan meant to reduce estate exposure may involve a basis tradeoff. Counsel should compare both sides before assets are transferred.

Gifting during life follows different basis rules

Giving an interest to a child while you are alive is not the same as leaving it at death. Section 1015 generally carries the donor’s basis into a gift, subject to special loss-basis rules and possible adjustments for gift tax. The recipient does not simply use current market value for all purposes. [7]

For example, assume a qualifying gift of an appreciated interest worth $500,000 with a $200,000 adjusted basis. Ignore gift-tax basis adjustments and other special rules. The recipient’s basis for gain would generally remain $200,000. A later $520,000 net sale would produce $320,000 of gain.

If the same interest instead passed at death and qualified for a $500,000 basis under Section 1014, that hypothetical later sale would produce $20,000 of gain, assuming no other changes. This compares two basis paths. It is not advice to delay gifts. It is not a full estate-tax comparison. [1] [7]

There is also an anti-cycling rule. Appreciated property given to someone within one year before that person’s death and then returned to the donor or donor’s spouse generally retains the decedent’s adjusted basis under Section 1014(e). A quick gift-and-inherit plan should not be treated as a basis reset. [1]

Joint ownership and community property need separate review

Who owns which share affects what may adjust at death. A married couple’s title, the source of ownership, and state property law matter. One spouse’s death does not automatically reset every jointly held asset to full market value.

The IRS explains a general approach for a qualified joint interest held by spouses: part of the property is included in the deceased spouse’s estate, while the survivor retains the relevant basis in the surviving share. The resulting basis combines components; it is not simply a full new purchase. [4]

Community property has a special rule. Section 1014(b)(6) can apply to the surviving spouse’s half when its requirements are met, including the condition concerning inclusion of at least half of the community interest in the gross estate. Whether an interest is actually community property must be established. [1]

Do not change ownership based on a general article’s description. A transfer can affect control, creditors, marital rights, estate treatment, and tax results. Ask the estate attorney to review the exact title and trust provisions, then give the preparer the supporting documents.

Income tax and estate tax are different questions

A basis adjustment concerns the tax basis of property. Estate tax concerns the transfer at death and the estate’s assets, deductions, gifts, credits, and other rules. An asset can receive a basis adjustment while still being relevant to an estate-tax calculation.

The IRS describes the gross estate as including property and certain interests valued at fair market value, not simply their original cost. Deductions and credits then affect the tax analysis. Do not assume that because a DST is passive, it is outside the estate. [8]

Conversely, a person does not necessarily have to owe federal estate tax for qualifying inherited property to receive the general basis treatment. Section 1014 identifies categories of property; it does not impose a blanket requirement that the estate actually pay tax on every qualifying asset. [1]

Have the adviser check filing duties and any elections even when no payment seems likely. State estate or inheritance rules also need a separate review where relevant. This guide does not apply one federal threshold to every family, citizenship status, or state.

Valuation is part of the work, not a footnote

A basis claim needs support. For a private DST interest, a sponsor’s account statement may provide information, but it is not automatically the right evidence for every estate and income-tax purpose. Ask counsel and the valuation professional what must be valued and on which date.

That review may need to address the real estate, debt, and interest’s terms. The ownership structure matters too. Do not invent a discount or assume the original subscription amount remains fair value. A headline building appraisal and the investor’s interest are not interchangeable figures without analysis.

The general rule uses date-of-death value. Alternate valuation and special-use rules can apply when their requirements are met; they are not unrestricted choices of whichever date produces the highest basis. Section 1014 also includes basis-consistency rules for covered property. [1]

Keep the signed valuation, supporting reports, ownership schedule, and any required beneficiary basis statements. If the final value differs from a working estimate, make sure the tax records are updated. Otherwise, a later sale may be reported using a number the family never intended to treat as final.

What the basis adjustment does not erase

A new basis does not stop tax reporting after death. Rental income and other taxable items can arise while the estate or heirs hold the investment. Later depreciation and other adjustments can change basis again. Future appreciation can create new gain.

Section 1014 also excludes a right to income in respect of a decedent from its basis rule. The preparer must identify any such items instead of treating every payment received after death as part of a newly valued asset. [1]

The family also remains exposed to the properties and the structure. Tenant problems, debt, fees, and a weak sale market do not disappear. A basis adjustment may reduce a future income-tax cost. It cannot restore money lost through poor investment results.

Private offerings may have severe resale limits and may not provide the information or protections familiar from public securities. The SEC warns that investors may have to hold them indefinitely and can lose their full investment. Estate planning should account for that possibility rather than treating inheritance as a route to liquidity. [5]

Plan the handoff before the family needs it

One reason to consider passive real estate is to spare heirs the work of running a building. Yet fewer property tasks do not mean no estate tasks. Someone still needs to establish authority, contact the sponsor, track payments, arrange tax reporting, and review proposed transactions.

Ask what happens when an investor dies or becomes unable to act. Find out which documents the sponsor needs, whether transfers require approval, and how contacts are changed. The estate plan should name who acts and provide access to the records needed to do the job.

Consider heirs with different needs. One may want regular income; another may need cash for a home or care. Dividing a private interest can require documents, approvals, and tax analysis. It does not guarantee that either heir can sell their portion when they choose.

A written family guide should identify the holdings, advisers, governing documents, tax records, and current questions. Avoid storing passwords openly in that guide. The goal is a clear legal and financial handoff. It should not give broad access to private accounts.

Set aside cash for costs that cannot wait

An estate can have bills before an investment sells. Taxes, administration costs, property-related expenses, or beneficiary needs can create a timing problem. Map those obligations against liquid assets that are actually available to the person responsible for paying them.

Suppose an estate has $75,000 of cash available for $45,000 of near-term costs and a possible $50,000 later bill. The full $95,000 cost scenario leaves a $20,000 gap. A large DST value on a statement does not close that gap unless a usable source of cash exists.

This hypothetical is not a reserve recommendation. Each family needs its own estimate and legal review of which assets can pay which obligations. The point is to identify the shortfall before the executor has to seek a buyer for an illiquid investment under pressure.

Likewise, consider your own needs during life. A tax benefit that might arise at death is a poor reason to lock away money needed for housing, health care, or ordinary living costs now. The investment has to fit the owner before it can fit the estate.

Use a coordinated review before choosing the investment

Ask the estate attorney to explain the ownership and transfer plan. Ask the tax adviser to document the basis treatment during life and at death, including exceptions. Ask the investment professional to explain the business plan, fees, control limits, and risks of the actual offering.

Then compare the DST with keeping the existing property, hiring a manager, or making a taxable sale and using different assets. A potential basis benefit shared by several choices does not establish which choice is best. Fees and expenses also affect the money available to the family. [9]

Keep the conclusions dated. Review them after major family changes or a property sale. A new trust or law also calls for review. The plan works better when its documents still match the family’s needs and holdings.

Frequently asked questions

Do DST interests always receive a step-up at death?

No. The interest’s tax structure and the way it passes must qualify under the applicable rules. The general basis rule is fair market value, which can produce a step-down as well as a step-up. Trust ownership and special exceptions can affect the outcome. [1]

Is this an estate benefit unique to DSTs?

No. Section 1014 applies to qualifying inherited property more broadly. A directly owned rental can also qualify. The reason to choose a DST should include its real estate, management arrangement, costs, and fit, not a claim that only DSTs receive an inherited basis adjustment. [1]

Does a step-up pay money to my heirs?

No. It changes the tax basis used in relevant calculations. It does not distribute cash, pay estate bills, or create a buyer for the investment. Your heirs still need a practical plan for cash needs and the offering’s resale limits. [5]

Does an irrevocable grantor trust get the same treatment?

Not necessarily. Grantor status determines income-tax ownership but does not alone establish a basis adjustment. Revenue Ruling 2023-2 denied the adjustment under its specific facts involving assets outside the gross estate and no other qualifying Section 1014 category. [6]

What if I give the DST interest to my child now?

A lifetime gift generally follows carryover-basis rules for gain, with special rules for losses and gift-tax adjustments. It is not the same as a qualifying transfer at death. Compare estate, gift, income-tax, and control effects before making a transfer. [7]

Will my spouse receive a full basis adjustment?

That depends on ownership and applicable law. Qualified joint interests and qualifying community property can follow different rules. Have counsel review the title, trust, and community-property status rather than assuming that marriage alone resets the full investment basis. [1] [4]

Must heirs continue doing 1031 exchanges?

They are not required to pursue exchanges merely because the prior owner used them. Their choices depend on who owns the property, the investment’s terms, and the available transaction. After any basis adjustment, compare the actual tax on a sale with the costs and risks of continued investing. [3]

Can we rely on the sponsor’s statement as tax basis?

Not without confirming what the number means. Account value, invested cash, underlying property value, and tax basis can differ. The preparer should use the relevant valuation and basis records, including any applicable estate reporting and consistency rules. [1] [4]

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.