Important: I’m a real estate agent, not an attorney or CPA. This article is general real estate context, not legal or tax advice. Step-up in basis, estate tax, probate, trust administration, and 1031 exchanges all need review by the right professional. My role is the real estate side: value, property strategy, sale preparation, property search, negotiation, and transaction management.

What Is a Step-Up in Basis?

When you inherit property, U.S. tax law may reset the cost basis of that asset to its fair market value on the date of the original owner’s death. This reset is called the step-up in basis.

Any appreciation that occurred during the decedent’s lifetime may be removed from the capital gains calculation for the heir. If your parent bought a home in 1985 for $90,000 and it’s worth $1.2 million at the time of their death, the inherited basis may be $1.2 million. If the property later sells for that amount, the pre-inheritance gain may not create capital gains tax for the heir. Confirm the result with a CPA or tax advisor before relying on it.

Step-up in basis can change the tax result when inherited real estate is sold. The exact result depends on the facts and current tax law.

Understanding Cost Basis

Before we go further, it helps to understand what cost basis means in plain terms. Your cost basis in a property is generally what you paid for it, plus the cost of any improvements you made over the years, minus any depreciation you’ve claimed.

When you eventually sell an asset, capital gains tax is generally calculated on the difference between your sale price and your cost basis. A low basis relative to today’s value can mean a large taxable gain. A basis that has been stepped up to current market value can mean a smaller gain when the inherited property is sold.

This is why the step-up matters so much: it resets the starting line for capital gains calculations, often eliminating a tax bill that could otherwise run into the hundreds of thousands of dollars.

Why Fair Market Value Matters

The stepped-up basis is generally tied to the property’s fair market value (FMV) on the date of the decedent’s death. This is not an estimate you want to guess at later. It needs documentation.

For real estate, a formal appraisal conducted at or near the time of death is the standard approach. A real estate agent can help with market context, but a date-of-death valuation for tax purposes should be handled by the right professional. If you cannot prove basis to the IRS, the result can be costly.

Acting promptly matters. Getting an appraisal done in the weeks immediately following a death is far easier than trying to reconstruct value years later when you decide to sell.

Estate Tax vs. Capital Gains Tax

These are two separate taxes, and it’s important not to confuse them.

Estate tax is levied on the total value of a decedent’s estate before assets are transferred to heirs. For 2026, the IRS lists the federal basic exclusion amount at $15,000,000 for estates of decedents who die during 2026. Most estates do not owe federal estate tax, but high-value estates need professional review.

Capital gains tax is what an heir may owe if and when they sell an inherited asset at a profit above the stepped-up basis. Step-up in basis is specifically a capital gains issue. It does not reduce estate tax. Both taxes can potentially apply to the same estate, depending on its size.

Key distinction: Step-up in basis does not reduce estate tax. It may reduce capital gains tax when heirs sell inherited assets. Large estates may still owe estate tax. Confirm with an estate planning attorney and CPA.

Assets That Qualify for Step-Up in Basis

The step-up applies broadly to assets included in a decedent’s taxable estate. Common qualifying assets include:

Real Estate

Residential homes, rental properties, commercial buildings, and raw land may qualify, including properties acquired through 1031 exchanges.

Stocks & Bonds

Individually held shares, mutual funds, ETFs, and bonds receive a stepped-up basis to their fair market value on the date of death.

Business Interests

Ownership stakes in partnerships, LLCs, S corporations, and other pass-through entities generally qualify if included in the estate.

Collectibles

Art, antiques, jewelry, wine, classic cars, and similar tangible assets held at death qualify for the step-up in basis.

Assets That Do Not Qualify

Not every asset benefits from a step-up. These are common categories to review with a tax professional:

  • IRAs and tax-deferred retirement accounts: Distributions from inherited traditional IRAs are taxed as ordinary income. There is no step-up in basis for these accounts.
  • Annuities: Earnings inside inherited annuities are generally subject to income tax when withdrawn.
  • Property gifted during the owner’s lifetime: If someone gives you an appreciated asset while they’re still alive, you may receive their original cost basis, not the current fair market value. This is one reason lifetime gifts need tax review before anyone transfers real estate.

Date of Death Valuation

Establishing the stepped-up basis requires careful documentation of fair market value at the time of death. Here’s what that typically looks like for real estate:

  • Hire a licensed appraiser to conduct a retrospective appraisal as close to the date of death as practical
  • Retain a copy of the appraisal report in a secure place you can access years later if needed
  • If the estate goes through probate, the probate court may also establish values for major assets
  • For properties in trust, the trustee typically handles this documentation Don’t wait years to sell and then scramble to prove what the property was worth at the time of the original owner’s death. Establishing value promptly protects you and simplifies the eventual sale.

Planning Questions to Discuss With Advisors

Step-up in basis affects real estate decisions, but the planning belongs with a qualified attorney and CPA. These are the questions to raise with them:

  • Should appreciated real estate be sold during life or held?
  • Would a 1031 exchange fit the investment plan?
  • How does California community property affect basis after one spouse dies?
  • Should any property be gifted during life?
  • Do the trust, title, and beneficiary designations support the intended result?

For the real estate side, the practical questions are value, timing, property condition, market demand, and whether a sale or exchange target makes sense.

What About 1031 Exchange Properties?

This is where things get particularly interesting for real estate investors.

A 1031 exchange under IRS Code §1031 can defer capital gains taxes when you sell investment real estate and reinvest the proceeds into a like-kind property. You carry over your original cost basis into the new property. The tax is deferred, not eliminated.

If you hold that 1031 exchange property until death, your heirs may inherit it at fair market value on the date of death. According to First American Exchange Company, prior deferred gain may be eliminated when the inherited basis is stepped up. Confirm the result with an exchange facilitator and tax advisor.

Example: You bought a rental property in 1995 for $150,000. Over two decades you completed three 1031 exchanges, growing the portfolio to a property now worth $2.2 million. Your carried-over basis may still be close to $150,000. If you sell during life, there may be a large taxable gain. If the property is inherited and qualifies for a stepped-up basis, the tax result may be very different.

This is one reason long-term real estate investment, combined with estate planning, can matter. The structure has to be reviewed before anyone relies on it.

Heirs who inherit 1031 exchange property may be able to use a future 1031 exchange if the property is held for investment use, but the rules are specific. Consult a qualified exchange facilitator and tax advisor before assuming that’s an option.

The Bottom Line

The step-up in basis is part of U.S. tax law under Internal Revenue Code §1014. How it applies depends on the estate, the asset, the title, the timing, and current law.

For heirs who stand to inherit appreciated California real estate, the step-up can materially affect the sale decision. For investors building a portfolio through 1031 exchanges, it can affect long-term planning.

As a real estate agent, I don’t give tax advice. That is your CPA’s and estate attorney’s domain. I can help you think through how a potential sale, inheritance, or exchange fits into the real estate picture, and connect you with the right specialists. If you’re working through any of this in the context of Santa Cruz County real estate, I’m happy to be a resource. For a sense of current market values, the market stats page has recent data.

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Questions About Inherited Property or 1031 Exchanges?

Whether you’re dealing with an inheritance, planning a 1031 exchange, or thinking through an estate strategy, I’m happy to talk through the real estate side and connect you with the right specialists for the legal and tax pieces.

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Frequently Asked Questions

What is step-up in basis? When you inherit property, U.S. tax law may reset the cost basis of that asset to fair market value on the date of the original owner’s death. For real estate, document that value and confirm the tax result with a qualified advisor. Learn more at First American Exchange Company.

Does step-up in basis apply to 1031 exchange properties? It can. When a taxpayer who used 1031 exchanges to defer capital gains passes away, heirs may inherit the property at fair market value on the date of death. According to First American Exchange Company, deferred gain may be eliminated through step-up in basis. Confirm the result with an exchange facilitator and tax advisor.

What assets qualify for step-up in basis? Real estate, stocks and bonds, business interests, and collectibles generally qualify. Assets that do not qualify include IRAs and tax-deferred retirement accounts, annuities, and property gifted during the owner’s lifetime. See firstexchange.com for additional resources on how this interacts with investment real estate.

What is the difference between estate tax and capital gains tax? Estate tax is levied on the total value of a decedent’s estate before assets are transferred to heirs. Capital gains tax may be owed when an heir later sells an inherited asset at a profit above the stepped-up basis. Step-up in basis addresses capital gains tax, not estate tax. Both can apply to the same estate depending on its size. Consult a qualified estate planning attorney for guidance on your specific situation.

How is fair market value established at the date of death? For real property, a formal appraisal conducted at or near the time of death is the standard method. The IRS requires documentation; if no basis can be proven, the IRS may treat it as zero. Acting promptly to establish value protects heirs. First American Exchange Company and other exchange facilitators can also provide guidance on how basis documentation works in the context of 1031 exchange properties.

Can you use a 1031 exchange on inherited property? In some cases an heir can use a 1031 exchange if the inherited property is held for investment use. The rules around inherited property and exchanges are specific, so consult a qualified exchange facilitator such as First American Exchange Company and a tax advisor before proceeding. As your real estate agent, I can handle the property search and transaction side while the exchange facilitator manages the exchange structure.