Step-up in basis

The step-up in basis is the single most powerful provision in real estate tax, and it is the reason every deferral strategy in this pillar has a happy ending. When you die, your heirs do not inherit your low, depreciated tax basis. Under Section 1014, their basis resets to the property’s fair market value at your death. Every dollar of gain, every dollar of depreciation recapture, everything you deferred for decades, vanishes. The IRS never collects it. It is estimated to be one of the largest single tax breaks in the entire code.

What actually resets, and it is everything

The step-up is a clean sweep, and understanding its completeness is the point. When your heirs inherit real estate at a stepped-up basis, four things reset to zero at once.

The long-term capital gain, all the appreciation above your original purchase price, is erased. The unrecaptured Section 1250 gain, the depreciation on the building that would have been taxed at 25%, is erased. The Section 1245 recapture, the ordinary-income tax on all the accelerated and bonus depreciation from any cost-segregation study you ran, is erased. And the net investment income tax exposure on the deferred gain goes with it. Your heirs’ basis becomes the market value at your death, as if they bought the property fresh that day. If they sell it immediately at that value, they owe no federal tax whatsoever, not on the gain, not on the recapture, not on anything.

At death, the step-up resets your heirs’ basis to market value, erasing the capital gain, the 25% depreciation recapture, the ordinary-rate cost-seg recapture, and the NIIT, all at once.

Why this makes deferral into forgiveness

Now the whole pillar clicks into place. A 1031 exchange defers gain and recapture, but it never forgives them; the liability rides in the carryover basis, growing as you exchange into bigger properties. The step-up is what forgives it. Defer through a lifetime of exchanges, never triggering the tax, and then die, and the entire accumulated liability, decades of deferred gain and recapture across every property in the chain, is wiped out for your heirs.

This is why aggressive depreciation, cost segregation, and serial 1031 exchanges are not just deferral, they can be permanent avoidance, if you hold until death. The bigger the deferred liability you build up, the more the step-up erases. An investor who cost-segregates aggressively, defers through exchanges, and holds to death has legally converted what would have been an enormous tax bill into zero. The strategy has a name, developed on the next page: swap until you drop.

A 1031 only defers; the step-up at death forgives, so a lifetime of exchanges plus a step-up turns decades of deferred tax into permanent avoidance for your heirs.

The estate-tax counterweight

There is a ceiling to be aware of, though for most families it is very high. The step-up eliminates income tax, but a large enough estate can owe estate tax. The 2025 law set the federal estate and gift exemption at a permanent $15 million per person, $30 million per married couple, effective 2026, so estates below that owe no federal estate tax and get the full income-tax step-up for free. Above the exemption, the 40% estate tax can apply, and then the income-tax savings of the step-up have to be weighed against estate-tax exposure, which is where lifetime gifting and trust planning enter, covered in the estate planning material. For most investors, though, the estate is under the exemption and the step-up is simply free.

The bottom line

• Under Section 1014, heirs’ basis resets to fair market value at death, not your low basis.
• This erases deferred capital gain, 25% depreciation recapture, cost-seg recapture, and NIIT exposure at once.
• Heirs selling immediately at the stepped-up value owe no federal income tax.
• It converts a lifetime of 1031 deferral into permanent forgiveness of the whole accumulated liability.
• Estates above the $15 million exemption can owe estate tax, but most families get the step-up free.

For the strategy built on this, read death and the 1031. For the estate-tax side, see estate planning with LLCs. For the full picture, start at the 1031 exchanges and exit planning hub.

Last verified August 2026.