Published 08/27/2026
Step-Up in Basis and 1031 Exchanges: What Brokers Need to Know (Updated: July 2026)
Step-Up in Basis: The TL;DR
For brokers, understanding step-up in basis can help you spot important planning issues, ask better questions and know when to bring a client’s tax or estate advisor into the conversation.
A step-up in basis generally adjusts the tax basis of inherited property to its fair market value at the owner's death under IRC Section 1014. For investors who defer gains through 1031 exchanges, this adjustment may significantly reduce the built-in gain their heirs would otherwise face. An investor might consider a 1031 exchange during step-up in basis planning to defer current capital gains while preserving the possibility that heirs could later receive a basis adjustment at the investor’s death. Outcomes depend on individual facts and current law, so specifics should be discussed with a tax advisor.
What is a Step-Up in Basis?
Think of step-up in basis as the tax code’s reset button. When someone inherits property, its cost basis is generally adjusted to the property's fair market value as of the date of the previous owner's death, rather than carrying over what the original owner paid for it. A house bought in the 1960s, for example, and then passed down in today’s market would not still be worth its initial sale price.
The step-up in basis adjustment is governed by Internal Revenue Code Section 1014 as explained in IRS Publication 551, Basis of Assets. Step-up in basis is important for several reasons. On one hand, it is the figure the IRS subtracts from the sale price to determine a taxable gain. A lower basis produces a larger gain at sale; a higher basis produces a smaller one. Resetting the step-up basis at death may meaningfully shrink the gain an heir would recognize if they later sell.
Here’s how step-up in basis in real estate may come up in a conversation with your client. Imagine your client bought a small retail strip decades ago and watched it appreciate substantially. If they sold during their lifetime, they would generally owe tax on the gain measured from their original cost. But if they hold the property until death and it pass to their children, the children's basis is generally stepped up to fair market value on the date of death.
If the heirs then sell near that value, there may be little or no gain left to tax, because the appreciation that accrued during the parent's lifetime is generally not taxed to the heirs under current law.
For brokers, understanding stepped-up basis can help prevent an automatic “just sell it” response when holding the property may produce a different after-tax result for the next generation.
It's important to note that whether a given property receives this treatment, and to what extent, depends on how title is held, the state involved, and the specific facts of the estate, all of which should be vetted with the taxpayer's tax and legal advisors (in addition to discussing all the details with a broker or a chosen qualified intermediary).
How Does a Step-Up in Basis Work?
When discussing the issue with a client or helping them prepare for a conversation with their tax advisor, it helps to keep two numbers in mind: basis before death and basis after death.
An investor’s basis changes over the life of a property. It generally begins with the property’s purchase price, increases with certain capital improvements and acquisition costs, and decreases through depreciation deductions. When the investor completes a 1031 exchange, the deferred gain carries over to the replacement property through its basis rather than disappearing. As the investor continues exchanging and claiming depreciation, there may develop a growing gap between what a property is worth and its adjusted basis. When the owner dies, IRC Section 1014 generally resets the basis of inherited property to its fair market value as of the date of death, subject to the statute’s requirements and exceptions.
Let’s walk through an example a broker might encounter:
An investor originally purchased a rental property for $500,000.
Throughout two decades, they exchange up in value through a series of like-kind transactions, deferring the gain each time, and eventually hold a property worth $2,000,000.
Because deferred gains and years of depreciation followed them through those exchanges, their adjusted basis in that final property is only $300,000.
There is now roughly $1,700,000 of built-in gain sitting inside the asset.
What happens if they sell during their lifetime?
The $1,700,000 is exposed to capital gains taxation.
The 1031 exchange deferrals come to an end, and the IRS collects on a hefty bill.
How would that compare to a step-up in basis at death?
The heirs’ basis upon their inheritance is generally stepped up to the $2,000,000 fair market value under current law.
If they sell at or near that value, there may be little or no gain left to recognize, because the built-in gain that accrued during the investor's lifetime will not be taxed to the heirs as income.
The above scenario is the heart of any 1031 exchange step-up in basis conversation. Defer the capital gains during an investor’s lifetime and the step-up in basis at their death may reset the slate for the next generation.
Note: The above example is illustrative only. It assumes fair market value at death equals the sale price and does not account for every factor that affects a real transaction, including depreciation recapture, net investment income tax, state and local taxes, transaction costs, and how title is held. Always keep a tax or legal advisor in the loop when discussing this strategy.
What Happens to a 1031 Exchange When the Owner Dies?
If your client passes away while still holding replacement property, what does that mean for the deferred gain? In most cases, the death itself does not trigger the deferred gain. Death is not treated as a sale or other disposition that forces recognition of the built-in gain, so the tax that was carried forward through each exchange is generally not recognized as income simply because the owner has passed away.
For brokers, it can be helpful to think about the full 1031 exchange chain. Each properly structured exchange defers the gain from the relinquished property into the replacement property, and that deferral continues as long as the investor keeps exchanging and holding qualifying real estate. The deferred gain does not disappear along the way. Now, what happens when that chain stops?
Under current law, if the chain stops at death, the investor’s heirs will likely take the inherited property with a basis stepped up to fair market value under IRC Section 1014. The built-in gain that accumulated across all of those exchanges is generally reset out of the heirs' income tax picture, because their starting basis becomes the date-of-death value rather than the investor's low carryover figure.
Now, this brings in the question of: does a 1031 exchange defer taxes forever? The short answer is no. A 1031 exchange defers income tax on the gain during the investor's life, and the step-up in basis at death may, under current law, reset the basis so that the deferred gain is generally not taxed to the heirs as income. With this said, however, capital gains will ultimately play a role.
Because every 1031 has unique basis, titling, and estate structure, these questions belong with the taxpayer's tax and legal advisors. A qualified intermediary facilitates the exchange itself; it does not calculate basis, advise on how to hold title, or handle the estate plan. And keep in mind that income tax and estate tax are separate questions.
What is the “Swap ‘Til You Drop” Strategy?
Another planning concept brokers should know is “swap until you drop.”
This is the informal name given to a long-term approach that pairs serial 1031 exchanges with estate planning. The idea is straightforward: an investor keeps exchanging into new like-kind properties throughout their life, deferring the gain at each step rather than cashing out, and continues holding qualifying real estate until death, otherwise known as “when they drop.”
1031 exchanges address the “during life” side of the strategy by deferring gain as the client trades up or repositions a real estate portfolio. The estate planning side handles what happens when the exchanging stops, focusing on the stepped-up basis an heir may inherit when they take over the property.
This is a useful concept for brokers to understand because it can turn an aging client's "I'm tired of managing this building" comment into a timely conversation with their tax and estate advisors before the property is listed. Selling near the end of life may trigger the very gain that holding could have deferred and potentially reset.
Now, whether a “swap until you drop” strategy will work for your client is not guaranteed. Many factors, including title, state, and size of the portfolio, can influence the outcome of this strategy. They may also have personal or business considerations that necessitate liquidity in the present moment, rather than maintaining investment holdings.
Community Property vs. Common Law States: The Double Step-Up
Can step-up in basis at death vary based on where you live? It can, and the difference can be substantial. The dividing line is whether a couple’s property sits in a community property state or a common law (separate property) state.
In a common law state, when one spouse dies, generally only the decedent's share of jointly owned property is stepped up to fair market value. If the couple owned the property fifty-fifty, roughly half of it gets a fresh basis at fair market value, and the surviving spouse's half keeps its original, often much lower, basis.
Community property states, on the other hand, work much differently. Under IRC Section 1014(b) (6), when one spouse dies, both halves of the couple's community property are generally treated as acquired from the decedent for the purposes of step-up in basis. This means the entire property may step up to fair market value, not just the deceased spouse's half. Advisors sometimes call this the "double step-up," and for a highly appreciated property it can be the difference between a small residual gain and a large one.
To quickly illustrate this, let’s say a couple holds a rental property worth $2,000,000. They carry a $300,000 basis when one spouse dies. In a common law state, the survivor's basis might land somewhere near $1,150,000 (roughly their untouched half plus the stepped-up half). In a community property state, the full basis may reset to $2,000,000, generally leaving little built-in gain if the survivor then sells near that value.
As of July 2026, there are nine community property states: Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin. Because the double step-up turns entirely on state law, how title is held, and how any trust is structured, this is a question for the taxpayer's estate attorney and tax advisor. A qualified intermediary does not advise on titling or which state's rules apply. It is worth flagging early, though, because a broker who knows to raise the question can send a client to the right advisor well before it matters.
Does Step-Up in Basis Apply to Depreciation Recapture?
This is a very misunderstood corner in the step-up basis at death world. When a property passes at death, and the heirs receive a stepped-up basis, the depreciation the original owner claimed over the years generally does not carry over to the heirs.
Why does this matter? On a lifetime sale, the depreciation an investor deducted over the years is generally recaptured and taxed under its own rules, separate from ordinary capital gain. It is one of the reasons the tax bill on a long-held, heavily depreciated property can be larger than owners expect.
When basis is stepped up at death, though, the heirs generally take the property with a fresh basis at fair market value and without inheriting the decedent's accumulated depreciation. The recapture triggered by a lifetime sale is generally not passed on to them as income.
Any calculations surrounding step-up in basis fall to the client’s CPA or tax advisor, but brokers should understand the issue well enough to recognize when it may affect a client’s decision to sell or exchange.
What Do CPAs and Financial or Estate Advisors Watch for When Considering Step-Up in Basis?
A broker’s role is different from that of a CPA, attorney or wealth advisor. Brokers spot the issue, ask the right questions and make the introduction. The client’s advisors handle the tax and legal determinations. Here are the things those advisors tend to watch for once a property with deferred gain is on the table:
Holding intent near end-of-life: A recurring theme is what a client plans to do with a property late in life. When an aging investor is weighing a sale, advisors will often model the after-tax difference between selling now and holding, because a lifetime sale generally recognizes the deferred gain, while holding until death may allow a step-up in basis for the heirs under current law. The right strategy will depend on a client’s ultimate financial goals and family needs.
Gifting vs. inheriting: One of the most common questions advisors field is whether to transfer property during life or let it pass at death. One nuance advisors should watch for here: gifting appreciated property to someone near the end of life in the hope of having it pass back with a stepped-up basis generally does not work if that person dies within one year.
Ownership structure and entity elections: Advisors also look closely at how the property is held, because many investors own real estate through LLCs. For a single-member LLC that is disregarded for tax purposes, the underlying real estate generally steps up as much as directly held property would. For a multi-member LLC taxed as a partnership, the breakdown is different: the heirs generally step up the value of the membership interest they inherit, but the entity may need a Section 754 election so the inside basis of the real estate matches that stepped-up value.
Consistent-basis reporting: For estates large enough to file an estate tax return, advisors track the consistent-basis rule under IRC Section 1014(f) and the related reporting on Form 8971, which generally requires the basis the heirs use to align with the value reported for estate tax purposes.
Coordination across three professionals: The thread running through all of this is coordination. Swap until you drop, the double step-up, depreciation recapture, entity elections, and consistent-basis reporting only come together when three professionals work in concert: the CPA on basis and tax, the estate attorney on titling and the estate plan, and the qualified intermediary on the exchanges themselves.
Looking to help clients navigate real estate decisions involving 1031 exchanges and step-up in basis? First American Exchange Company helps brokers recognize exchange opportunities, understand the process and know when to bring in a client’s tax or legal advisor. Contact our team to learn more about your options.
First American Exchange Company facilitates 1031 exchanges and can provide practical process information, but does not provide tax or legal advice. Investors should consult their independent tax and legal advisors regarding their specific transaction.
FAQs
What is a step-up in basis?
A step-up in basis occurs when an inherited property's tax basis adjusts to fair market value at the owner's death under IRC Section 1014, which may reduce the taxable gain heirs face on a later sale.
What happens to a 1031 exchange when the owner dies?
Death generally does not trigger the deferred gain. Under current law, heirs typically take a stepped-up basis at fair market value, so that gain is generally not taxed to them as income.
Do heirs pay the deferred taxes from a 1031 exchange?
Generally not as income, under current law, because the step-up in basis at death resets the basis to fair market value. Specific outcomes depend on the facts and the advisors involved.
What is the “swap until you drop” concept?
It is a planning concept pairing serial 1031 exchanges with estate planning, deferring gain during life so heirs may receive a stepped-up basis at death. Results depend on facts and current law.
Does step-up in basis apply to depreciation recapture?
When basis steps up at death, the decedent's accumulated depreciation generally does not carry over to heirs under current law, so that recapture is generally not passed to them as income.
How does step-up in basis work for community property?
In community property states, both spouses' halves may step up to fair market value at one spouse's death under IRC Section 1014(b)(6), versus only the decedent's share in common law states.
What is the difference between step-up in basis and estate tax?
Step-up in basis is an income tax rule adjusting an heir's basis. Estate tax is a separate transfer tax on the estate's value. They are distinct scenarios with different thresholds.
How do heirs determine the basis of inherited property?
Basis is generally the property's fair market value at the date of death under IRC Section 1014, as explained in IRS Publication 551. A tax advisor can confirm the figure.
Can heirs sell inherited exchange property right away?
Generally yes. Because basis is typically stepped up to fair market value, a sale near that value may leave little or no gain to recognize under current law. Advisors should confirm specifics.
Can the step-up in basis rules change?
Yes. Step-up remains present law under IRC Section 1014, but it has been a recurring subject of reform proposals. Any planning should account for the possibility of future legislative change.