Real estate investors have used Section 1031 exchanges for decades to defer capital gains tax on the sale of investment property. What often gets less attention is what happens when that deferral runs into estate planning — and for married couples whose combined estate falls at or under the current federal estate tax exemption, the combination can eliminate the deferred tax altogether rather than merely postponing it.

How the deferral works.  Under Section 1031, an owner who sells real property held for investment or business use can roll the proceeds into “like-kind” replacement real property and defer recognition of the capital gain. The tax isn’t forgiven; it’s carried forward. The replacement property takes a reduced, carryover basis that reflects the gain deferred from the relinquished property, so the built-in gain simply moves forward to the next asset. An investor who keeps exchanging over the years — sometimes called “swapping until you drop” — can defer gain indefinitely, but each exchange leaves the embedded gain a little larger.

How basis step-up erases it forever!  Section 1014 provides that once the taxpayer passes away owning appreciated property, the heirs generally take a basis equal to the property’s fair market value on the date of death, rather than the decedent’s carryover basis. That step-up wipes out the entire built-in capital gain for income tax purposes — including gain deferred through one or more prior 1031 exchanges and, notably, the depreciation recapture that would otherwise have been due on a lifetime sale. In a community property state, the benefit is even broader: both halves of community property typically receive a full step-up on the death of the first spouse, not just the decedent’s half.

And, Put Together … Put the two together and the strategy is straightforward: defer gain through 1031 exchanges during life, hold the replacement property (or its successors) until death, and let Section 1014 erase the accumulated gain rather than ever selling and triggering it.

Only Complicated if the Estate is over $30 Million. For very large estates, this strategy carries a cost. Property held until death is included in the owner’s gross estate at fair market value, and any value above the available exemption is subject to federal estate tax at a 40% rate. For those estates, the income tax savings from basis step-up have to be weighed against the estate tax exposure created by holding the appreciated asset — which is why ultra-high-net-worth planning often turns to gifting strategies, grantor trusts, or sales to defective grantor trusts to move future appreciation out of the estate entirely.

Why the calculus changes under $30 million.That tradeoff disappears for couples whose combined estate falls at or under the current federal exemption. For decedents dying in 2026, the basic exclusion amount is $15,000,000 per person. With portability — electing on a timely filed estate tax return to carry a deceased spouse’s unused exemption forward to the survivor — a married couple can shelter a combined $30,000,000 from federal estate tax. The One Big Beautiful Bill Act made this higher exemption permanent, removing the scheduled reversion to roughly half that amount that prior law had set for 2026. For a couple under that combined threshold, there is no tradeoff to weigh. The appreciated real estate passes to heirs free of federal estate tax, and it receives a full basis step-up under Section 1014 at the same time. The capital gain deferred through years of 1031 exchanges — along with any depreciation recapture — is eliminated for income tax purposes without costing a dollar of estate tax. Income tax deferral during life converts, at death, into permanent income tax forgiveness, with no estate tax offset. That is a materially better outcome than the same strategy produces for an estate above the exemption, where the same step-up comes bundled with a 40% tax on the excess value.

A Few Caveats …This federal analysis doesn’t account for state estate or inheritance tax (not applicable in many states, as in Florida, Nevada, Virginia) – that is so because there are still  several states impose their own estate tax with exemptions far below the federal $30 million figure — a couple comfortably under the federal threshold may still owe state estate tax.

And literally, little to do! Portability (taking advantage of the first spouse’s exemption of $15 million)  is not automatic; it requires a timely filed Form 706 on the first spouse’s death, even when no federal tax is owed. And because the federal exemption is a moving target relative to a couple’s net worth — asset growth, future gifts, or a change in the law could push an estate above the line — this is a position worth revisiting periodically with an estate planning advisor rather than assuming it forever.