Swap Till You Drop: What Happens to a 1031 Exchange When You Die

How the step-up works

When you die owning real estate, your heirs' basis in it is its fair market value at your death (or six months later if the executor elects alternate valuation). It doesn't matter what you paid, what you depreciated, or how much gain you deferred through exchanges. A building you bought in 1985 for $200,000, exchanged four times, and hold at death worth $3,000,000 passes to your children with a $3,000,000 basis. They can sell it the next month for $3,000,000 and owe no income tax. The $2,800,000 of gain and every dollar of recapture across four decades is gone.

Depreciation restarts for the heirs on the stepped-up basis of the building portion, so they also get a fresh deduction schedule. Details on the heir's side are in selling inherited rental property.

Why this makes serial exchanging rational

A single 1031 exchange defers tax. A lifetime of them, ending at death, eliminates it. That changes the analysis of whether an exchange is worth it: the deferred tax isn't a liability you're carrying, it's capital you're using, and under current law it never comes due. Investors in their sixties and seventies exchanging into DSTs (zero-cash-flow structures, no management) or through the UPREIT path are doing exactly this: parking the equity somewhere passive and holding until the step-up.

Estate tax: the other side of the ledger

The step-up is an income-tax rule. The estate tax is separate and applies to the total value of what you own at death above the exemption. Under the 2025 tax law the federal exemption is $15 million per person for 2026, indexed for inflation, and portable between spouses, so a married couple can pass $30 million before federal estate tax applies. Some states have much lower exemptions (New York's is about $7 million, with a cliff; Massachusetts and Oregon start at $2 million and $1 million). An investor with a large real estate portfolio needs an estate planner working alongside the exchange strategy, not instead of it.

Three ways families forfeit the step-up

1. Gifting the property during life. A gift carries your basis to the recipient (IRC §1015). A parent who deeds a rental to a child to 'keep it out of probate' hands them the deferred gain and the recapture. Use a revocable trust for probate avoidance instead; assets in a revocable trust still step up.
2. Adding a child to the deed as joint tenant. The child's half is treated as a gift with carryover basis; only the parent's half steps up at death. Same problem, half the size.
3. Holding through an entity without a §754 election. If the property sits in a partnership or multi-member LLC, the heir inherits the entity interest at stepped-up value, but the entity's basis in the building doesn't change unless the partnership makes a §754 election. Without it, the heir's share of future depreciation and gain is computed on the old basis. Ask the CPA whether the election is in place.

Spouses and community property

In common-law states, when one spouse dies, only the deceased spouse's half of jointly held property steps up. In community-property states (Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, Wisconsin), the entire property steps up at the first death, which can double the benefit. Couples who moved from a community-property state should have their planner check whether the property retained its character.

Could the law change?

Proposals to limit the step-up or to tax unrealized gains at death have surfaced repeatedly and have not passed. The 2025 tax law left §1014 intact and raised the estate exemption. Plan on current law, but hold property in a way that gives your heirs options either way: a revocable trust, clear title, and an appraisal ready to be ordered.