The Estate Planning Endgame

The interaction is the reason exchange practice exists at the volume it does, and it is also the reason the provision draws the criticism examined at 3.5. A practitioner should understand both.

46.1 Section 1014 and the elimination of deferred gain at death

The basis of property acquired from a decedent, or to which the property passed from a decedent, is the fair market value of the property at the date of the decedent's death, or its value at the alternate valuation date where that election is made, or its value under the special use valuation provision where that applies.¹

The consequence for an exchange chain is total. The successor takes a basis equal to value, and every element of the deferral disappears with the old basis: the gain deferred at each exchange, the unrecaptured section 1250 gain accumulated over decades of straight line depreciation, and the section 1245 recapture potential that Chapter 37 showed migrating from property to property. None of it is reflected in a fair market value basis, and none of it is ever taxed.

Three provisions complete the picture and each answers a question that arises in practice.

The revocable trust does not impair the result. Property acquired from a decedent includes property transferred by the decedent during life in trust to pay the income to the decedent for life, with the right reserved to revoke the trust or to alter, amend, or terminate it.² The revocable living trust that Chapter 19 established is transparent for exchange purposes is equally transparent here.

The deathbed transfer does not work. Where appreciated property was acquired by the decedent by gift during the one year period ending on the date of death, and the property is acquired from or passes from the decedent to the donor or the donor's spouse, the basis in the hands of the donor or spouse is the decedent's adjusted basis immediately before death.³ The plan of transferring low basis property to a dying relative to recover it with a stepped up basis was foreclosed decades ago.

Basis must be consistent with the estate tax return where the property's inclusion increased the estate tax liability.⁴ For an estate that pays no tax, that consistency requirement does not bind, which is the ordinary case under the exclusion amount described below.

The estate tax context has recently moved in the taxpayer's favor. The basic exclusion amount is $15,000,000, and for decedents dying in a calendar year after 2026 that amount is adjusted for inflation using calendar year 2025 as the base.⁵ For all but the largest estates the property receives a basis adjustment and no transfer tax is paid on it, which is the combination that makes the strategy work.

46.2 Exchange, refinance, and hold

The strategy has three steps and only the middle one requires explanation.

Exchange to defer. Each transaction moves the gain forward into the basis of the next property, as Chapter 35 computes.

Refinance to extract cash. Borrowing against appreciated property is not a realization event. The taxpayer receives money and incurs a liability, there is no amount realized, and no gain is recognized. A property that has doubled in value can be refinanced to return the owner's equity in cash without any tax.

Hold until death. The basis adjustment eliminates the accumulated deferral, and the debt remains a liability of the estate. The basis adjustment is made without regard to the debt, so a heavily encumbered property still takes a fair market value basis.

Four constraints qualify the middle step, and they are the whole of the risk.

The refinancing must not be part of the exchange. Where a borrowing is undertaken in contemplation of and as part of an exchange, the step transaction analysis of 34.4 and 42.1 applies, and the loan proceeds may be treated as boot. The safest sequence is to complete the exchange, hold the replacement property, and finance it later as a separate decision documented on its own terms.

Refinancing does not increase basis. The taxpayer receives cash and no depreciable basis. The deduction stream is unchanged by the borrowing, and the interest is subject to its own limitations.

The property must service the debt. This is a credit question rather than a tax question, and it is the one that has ended the strategy for real people. A property refinanced to its limit in a strong market and then subject to a rate reset or a tenancy loss is a property the owner may be forced to sell.

A forced sale is catastrophic. A property whose debt exceeds its basis carries the built-in minimum gain of 34.3, and a sale produces tax measured against debt relief rather than against cash received. A taxpayer who has exchanged four times and refinanced twice may face a tax bill that exceeds the net proceeds of a sale. The strategy is not a strategy for a taxpayer who may need liquidity; it is a strategy for a taxpayer who will hold.

The honest way to present it is as a bet on holding. If the client holds, the deferral becomes permanent and the refinancings were tax free returns of capital. If the client is forced to sell, the client sells at the worst possible tax posture, having stripped the equity that would have paid the tax.

46.3 Basis planning across generations

Three sequencing questions arise once the endgame is understood, and the answers are consistent.

Do not gift appreciated exchange property during life. Property acquired by gift takes the donor's basis.⁶ A lifetime gift of property carrying a large deferred gain transfers the gain along with the property and forfeits the adjustment that would have eliminated it. Where the objective is to move value to the next generation, the property is usually the wrong asset to move.

Do not exchange late in life merely to defer. This is the point that most often goes unsaid, and it parallels the estate analysis of 22.1. The economic value of an exchange is the time value of the deferred tax. Where the basis adjustment will eliminate the tax entirely, an exchange undertaken near the end of a holding period buys nothing, and it costs an intermediary fee, forty five day and one hundred eighty day deadline risk, constrained property selection, and the possibility of a failed exchange that accelerates the very tax the client was avoiding.

An older client who wants to change properties for genuine investment reasons should still exchange. An older client who is exchanging only because selling would be taxable should be told that holding accomplishes the same thing with no execution risk.

Consider what the heirs will actually receive. A single building divided among four children is a governance problem, and it is a problem that arises at the worst moment. Where division is foreseeable, the vehicles of Chapter 21 deserve consideration during life. A Delaware statutory trust interest, or interests in a tenancy in common, may be divided more cleanly than a fee, and the basis adjustment applies to whatever interest the decedent held.

One point applies to clients with a connection to a community property jurisdiction. The surviving spouse's one half share of community property held under the community property laws of any State, possession, or foreign country receives a basis adjustment where at least one half of the community interest was includible in the decedent's gross estate.⁷ Maryland is not a community property State, but a client who acquired property while domiciled in one, or who has used a community property trust, may have a materially better basis result than a Maryland analysis alone would suggest. The question is worth asking rather than assuming.

46.4 Proposals to curtail the step-up

A plan that depends on two provisions surviving for the rest of a client's life should be described accurately, and accuracy here means separating what the law is from what has been proposed.

What the law is. Section 1031 has not been amended since the Tax Cuts and Jobs Act in 2017, which limited it to real property.⁸ Section 1014 has not been amended since 2015.⁹ Both provisions are in force in the form described in this Part, and the exclusion amount that makes the basis adjustment valuable was recently increased rather than reduced.

What has been proposed. The executive branch's annual revenue proposals have repeatedly sought to curtail both, and the proposals are specific enough to be worth stating.

On exchanges, the proposal styled repeal of deferral of gain from like-kind exchanges would allow deferral up to an aggregate amount of $500,000 for each taxpayer, or $1,000,000 for married individuals filing a joint return, each year for like-kind exchanges of real property. Gains in excess of that amount would be recognized in the year the taxpayer transfers the property.¹⁰

On the basis adjustment, the proposal to treat transfers of appreciated property by gift or on death as realization events would have the donor or deceased owner realize capital gain at the time of the transfer, measured by the excess of fair market value on the date of the gift or death over basis, taxable to the donor or to the decedent's estate. The same proposal would require recognition by a trust, partnership, or other non-corporate entity owning property that has not been the subject of a recognition event within the prior ninety years, with a tacking rule for property received in a nonrecognition transaction from another such entity.¹¹

Neither has been enacted. They have been proposed in successive budget cycles and have not passed either chamber.

How to advise on this. Three things can be said honestly and a fourth cannot.

The current law is settled, and the direction of the most recent change was toward preserving the result rather than curtailing it.

Any change of this magnitude would almost certainly apply prospectively, and the ninety year deemed realization proposal, whatever its merits, is a demonstration that the drafters of such proposals expect to grandfather existing positions in some fashion rather than impose retroactive recognition.

A plan that depends entirely on the basis adjustment should be stress tested against its repeal. A client who has exchanged repeatedly on the assumption of a step up, and then faces realization at death, leaves an estate with a very large tax liability and an illiquid asset to pay it from. Liquidity planning, whether through insurance or through a portion of the portfolio held outside the exchange chain, is the ordinary answer and it costs little to put in place.

What cannot honestly be said is that the step up is either safe or doomed. That is a political judgment, it changes with each Congress, and a practitioner who advises a client to accelerate or defer a transaction on a prediction about legislation is trading on a forecast rather than on law. The policy arguments on both sides, including the objection that the combination of sections 1031 and 1014 amounts to an exemption rather than a deferral, are developed at 3.5.