Step-Up in Basis

A step-up in basis is the adjustment of an inherited asset's cost basis to its fair market value as of the decedent's date of death, under IRC Section 1014. Because basis determines taxable gain, this adjustment can be one of the most powerful features of the tax code for real estate investors. When an owner of highly appreciated property dies, the heirs generally take the property with a new basis equal to its date-of-death value, which effectively erases the built-in capital gain and depreciation recapture that accumulated during the decedent's lifetime. If the heirs sell shortly after inheriting, there may be little or no taxable gain. This interacts directly with tax-deferral strategies. Investors who use repeated 1031 exchanges, often described as "swap till you drop," or who convert property into OP units through a 721 exchange and hold them, can defer gain for life and then pass the asset to heirs at a stepped-up basis, potentially eliminating the deferred tax permanently. The step-up applies to property included in the decedent's estate; assets gifted during life generally retain the donor's carryover basis instead. Estate, gift, and basis rules are complex and subject to legislative change, so investors should plan with qualified tax and estate counsel.