Selling With a 1031 Exchange Series · Part 10
Exchange Until the End: Step-Up in Basis and Passing Property to Your Children
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Real estate investors have a saying: “Swap till you drop.” Keep deferring capital gains tax through 1031 exchanges until death, then leave the property to your children. The strategy works because of the federal “step-up in basis” rule.
What Is a Step-Up in Basis?
Under Section 1014 of the Internal Revenue Code, property inherited from a decedent generally takes a basis equal to its fair market value at the date of death (a “step-up in basis”).
That means the capital gains tax you deferred through 1031 exchanges during your lifetime, and the depreciation recapture from years of renting, are essentially wiped out for your heirs after your death.
The federal tax law signed in July 2025 preserved this rule.
An Example
Mr. Wang bought his first rental in 1990 for $300,000. Through several 1031 exchanges, he now owns a rental building worth $3 million, with an adjusted basis of only about $250,000.
| Scenario | Tax Result |
|---|---|
| Mr. Wang sells during his lifetime | A gain of about $2.75 million, subject to federal, New York State and New York City capital gains tax and depreciation recapture, possibly around $1 million in total |
| Mr. Wang gives the building to his children during his lifetime | The children take over his low basis (about $250,000) and face the same tax when they sell |
| Mr. Wang holds it until death and the children inherit | The children’s basis steps up to about $3 million, and if they sell right away for $3 million, there is essentially no taxable gain for income tax purposes |
This example is simplified and ignores estate tax. Have your accountant calculate the actual tax.
Income Tax Is Saved. What About Estate Tax?
A step-up solves income tax, not estate tax. The property’s value is still part of the estate:
| Item | 2026 |
|---|---|
| Federal estate tax exemption | $15 million per person |
| New York estate tax exclusion | $7.35 million per person |
| New York estate tax “cliff” | If the taxable estate exceeds $7,717,500 (105% of the exclusion), the exclusion disappears entirely and tax applies from the first dollar |
| Does New York allow portability between spouses? | No |
People who don’t live in New York but own New York real estate may also owe New York estate tax on that property if their total estate exceeds the New York exclusion.
So for families near or above the New York exclusion, a 1031 strategy should be planned together with estate tax planning.
Property Owned by Spouses: A New York Detail
New York is not a community property state. When spouses own property together and one dies, usually only the deceased spouse’s half receives a step-up, and the other half keeps its original low basis. This differs from California and other community property states and should be factored into planning.
Preparing to “Swap Till You Drop”
- Hold property in a revocable trust. Buy replacement property directly in the trust’s name, so a successor trustee can manage it if you become incapacitated and it passes without probate after death. Out-of-state property also avoids a separate probate there;
- Consider “LLC plus trust.” Hold rental property in an LLC to limit landlord liability, and put the LLC interest in the trust;
- Shift to passive assets later in life. If you no longer want to manage property, your last exchange can go into a passive investment such as a DST (see Part 6), which continues the deferral and still receives a step-up at death;
- Think carefully before lifetime gifts. A lifetime gift gives up the step-up, and New York adds taxable gifts made within three years before death back into the New York estate (currently for deaths before January 1, 2032);
- If you want to move into a replacement property in retirement, remember you must own it for five years after acquiring it before the home sale exclusion applies (see Part 4);
- Keep your family informed. Organize the history of your exchanges and the basis records for each property and give them to your trustee or executor, to make later calculations and sales easier.
Attorney’s Insight
For many New York landlords, a 1031 exchange is not just a tax technique at the time of sale but a lifelong wealth planning tool. From an attorney’s perspective:
- 1031 exchanges and estate planning should be considered together by one team. When the transaction attorney, the estate planning attorney and the accountant each work in isolation, the result is often “the tax was deferred but the property went through probate,” or “a gift lost the step-up”;
- The closer your assets are to New York’s estate tax cliff, the more important it is to plan early. A $7.35 million exclusion is not high in New York. A rental building plus a home and retirement accounts can bring many families close to that threshold;
- Every exchange is a good time to update your estate plan. How the new property is titled, who will manage it and who will inherit it are best arranged at the time you buy.
Attorney’s perspective
A 1031 strategy and an estate plan belong together. We help you weigh continuing to exchange, giving property during life or leaving it to your children, and coordinate the trust and will.
For advice about your own situation, call +1 718-218-5805 or schedule a consultation. We meet clients in Flushing and Manhattan, in English or Chinese.
This article is for general information only and is not legal advice. Reading it does not create an attorney-client relationship. For advice about your situation, please contact us.
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