The Short Answer
A step-up in basis resets the tax basis of an inherited asset to its fair market value on the date of the owner’s death. Under Section 1014 of the Internal Revenue Code, the appreciation that built up during the owner’s lifetime is generally not subject to income tax when the heir sells, and only the change in value after death is measured.
For investors who hold appreciated real estate, this rule shapes one of the largest decisions they face: whether to sell, exchange, gift, or hold. It also has limits that surprise many families, because several common assets do not qualify at all. If you want a starting figure for the tax at stake on a current sale, our real estate capital gains tax calculator can provide an estimate to review with your CPA.
How the Rule Works
Basis is the figure from which gain or loss is measured. For most assets acquired by purchase, it starts at cost and is adjusted over time, and depreciation lowers it. An owner who sells pays tax on the difference between the net sale price and that adjusted basis.
At death, Section 1014 replaces the decedent’s basis with fair market value for property acquired from the decedent. Three related points follow:
- Valuation date. The new basis is generally the value on the date of death. An executor may elect an alternate valuation date six months later, but only when doing so reduces both the gross estate and the estate tax due.
- Holding period. Inherited property is generally treated as held for more than one year, so a later gain can qualify for long-term rates even when the heir sells soon after receiving it.
- Step-down. The rule works in both directions. An asset worth less than its basis at death takes the lower value, and the built-in loss is gone. An owner holding a depreciated asset may want to discuss that with a CPA while the loss can still be used.
The step-up does not depend on whether the estate owes estate tax. The test is generally whether the asset is included in the gross estate, and most estates fall well below the federal exemption of $15 million per person for 2026.
A Hypothetical Illustration
Consider a hypothetical investor (and accredited investor) who purchased a rental property for $400,000 and has claimed $150,000 of depreciation. The adjusted basis is $250,000, and the property is now worth $1,200,000. Selling costs and state taxes are ignored, and the highest federal rates are assumed.
| Item | Sale during life | Heir sells shortly after death at the same value |
|---|---|---|
| Sale price | $1,200,000 | $1,200,000 |
| Basis | $250,000 | $1,200,000 |
| Taxable gain | $950,000 | $0 |
| Unrecaptured Section 1250 gain at 25% | $37,500 | $0 |
| Long-term capital gain at 20% | $160,000 | $0 |
| Net investment income tax at 3.8% | $36,100 | $0 |
| Illustrative federal tax | $233,600 | $0 |
The table isolates one variable. It leaves out what matters just as much in practice: market risk during the years of holding, the use the owner could have made of the sale proceeds, and the owner’s own need for income or liquidity. Your actual result will differ. Our depreciation recapture calculator shows how the recapture portion is estimated.
An heir who keeps the property may also begin a new depreciation schedule on the building portion of the stepped-up basis. Land remains non-depreciable, so an allocation is needed.
How It Interacts With a 1031 Exchange
A 1031 exchange defers gain by carrying the old basis into the replacement property. Repeat that over several decades, and the replacement property can hold a large embedded gain and a low basis. If the investor still owns that property at death, the deferred gain is generally not taxed to the heirs, since the basis resets. This sequence is often called “swap until you drop.”
Three cautions apply to that shorthand:
- It is a long plan with no assurance of completion. An exchange that fails, a boot event along the way, or a later need for cash can trigger some or all of the deferred tax.
- Tax law can change. Proposals to limit the step-up or to tax gains at death have appeared in past legislative debates. The current rules are what can be planned around, and they may not be the rules that apply in the future.
- It may not fit the investor. Holding an asset for decades in order to avoid a tax can mean carrying concentration risk or an illiquid position longer than the rest of the plan would support. In some cases, paying the tax is the right answer.
Fractional interests in a Delaware Statutory Trust are generally treated as direct ownership of real property for federal income tax purposes, so the same rule is generally understood to apply to them at death. Heirs may then hold or dispose of their interests only as the offering documents allow, since these investments are illiquid.
Why Texas Investors Should Look at Community Property
For married couples, how property is titled and characterized can double the effect of the rule.
Texas is a community property state. Under Section 1014(b)(6), when the first spouse dies, both halves of qualifying community property generally receive a new basis, as long as at least half of the community interest is included in the decedent’s gross estate. Spouses in most common-law states generally step up only the decedent’s half of jointly held property.
Returning to the hypothetical property above, suppose it is the surviving spouse who sells at $1,200,000, shortly after the first death:
| Characterization | Survivor’s new basis | Taxable gain |
|---|---|---|
| Community property, both halves stepped up | $1,200,000 | $0 |
| Half-only step-up (one half at $600,000 plus survivor’s half at $125,000) | $725,000 | $475,000 |
The character of each asset deserves a review, because not everything a Texas couple owns is community property. Assets owned before marriage, or received by gift or inheritance, are generally separate property. A partition agreement can change the character of an asset, and property acquired while living in another state may be treated differently. An estate attorney can confirm where each significant holding stands.
What Does Not Qualify
The exceptions below tend to be where families are surprised.
- Income in respect of a decedent. Traditional IRA and 401(k) balances, deferred compensation, and the remaining gain on an installment note do not step up under Section 1014(c). Heirs generally pay ordinary income tax on retirement account distributions.
- Lifetime gifts. Property given during life generally keeps the donor’s basis under Section 1015, so the built-in gain moves to the recipient.
- Deathbed gifts returned to the donor. Under Section 1014(e), if appreciated property is given to someone who dies within one year, and it passes back to the donor or the donor’s spouse, the donor’s prior basis generally applies.
- Assets outside the gross estate. Revenue Ruling 2023-2 concluded that assets in an irrevocable grantor trust that are not included in the gross estate do not step up at the grantor’s death. Assets held in a typical revocable living trust are generally included and generally do qualify.
- Deferred gain in an Opportunity Zone fund. Gain deferred through a Qualified Opportunity Fund carries over to the heir and is generally recognized as income in respect of a decedent when the inclusion date arrives.
- Entity-level assets. An interest in a partnership or LLC may step up at the owner level while the property inside the entity keeps its old basis, unless a Section 754 election or a similar adjustment applies. S corporation shares have no equivalent mechanism.
Practical Steps Worth Discussing
The following are general items to raise with your advisors, in no particular order of importance.
- Document value at death. A qualified date-of-death appraisal supports the new basis if it is ever questioned, and it is far simpler to obtain soon after death than years later. Heirs should keep it with their permanent records.
- Coordinate with the estate tax return. When a federal estate tax return is required, Section 1014(f) can require the heir’s basis to be consistent with the value reported, and executors may need to file Form 8971.
- Review gifting plans. Before transferring a low-basis asset to a child, compare what the gift could do for the estate with what the child would give up in basis.
- Choose which assets go where. Low-basis real estate and retirement accounts receive very different treatment at death, which can inform which heirs or charities receive which assets.
- Weigh the whole plan. A tax rule alone is a poor reason to hold an asset. Income needs, property condition, family dynamics, and management burden all belong in the decision.
Where to Start
The value of the step-up depends on your basis, your holding plans, your marital property status, and how your assets are titled. A useful first step is a list of your significant holdings with the estimated basis of each one. To see what a sale could look like by comparison, try our 1031 exchange calculator or read the definition of step-up in basis in our glossary. If you would like to talk through how these rules relate to a sale, an exchange, or an estate plan, we would welcome the chance to schedule a conversation and coordinate with your CPA and attorney.
This article is educational only and is not tax, legal, or investment advice. The scenarios are hypothetical and simplified for illustration, and actual tax results depend on individual facts and current law, which may change. Investments in 1031 replacement property, including Delaware Statutory Trusts, and investments in Qualified Opportunity Funds are speculative, illiquid private placements available only to accredited investors, involve substantial risk including possible loss of principal, and are offered solely through the sponsor’s offering documents. Nothing on this page is an offer to sell or a solicitation to buy any security, and there is no assurance that any tax strategy will achieve its intended result. Consult your CPA and attorney regarding your specific circumstances.