Does a 1031 exchange reduce estate tax?

Estate tax and the 1031 work on two different numbers

Section 2033 includes in the gross estate the value of all property to the extent of the decedent's interest at death, and Reg. section 20.2031-1(b) defines that value as the price between a willing buyer and a willing seller with reasonable knowledge of the facts. Basis plays no part. A $3 million building is a $3 million asset on Form 706 whether you paid $3 million for it or carried a $400,000 basis through five exchanges.

A 1031 exchange changes only basis and timing. Section 1031 postpones recognition of the gain, and your replacement carries the low basis forward. That gain is an income tax item, so it sits outside the estate tax computation entirely.

The two taxes meet at death. The estate pays estate tax on full value if the estate is large enough, and the heirs take a stepped-up income tax basis whether or not any estate tax was due.

Most estates owe nothing, so the income tax saving is the real prize

The IRS table of basic exclusion amounts shows $13,990,000 for 2025 deaths and $15,000,000 for 2026, after Public Law 119-21 amended section 2010(c)(3). Above the exclusion, the section 2001(c) rate table reaches 40% on the excess over $1,000,000 of the tentative tax base.

A surviving spouse can also inherit the first spouse's unused exclusion through the portability election on a timely filed estate tax return, covered in portability of the estate exemption. For a married couple that plans for it, very large real estate holdings can pass free of estate tax.

So for most families the exchange chain matters because of income tax. Every deferred dollar of gain and recapture disappears at death, which is the logic behind holding for the step-up and swap till you drop.

Worked example: selling instead of exchanging trims estate tax but costs more in income tax

Hypothetical, round numbers, state tax ignored; run your own numbers with your CPA. A widow with an $18,000,000 estate owns a $6,000,000 apartment building with a $1,000,000 adjusted basis, after $1,000,000 of depreciation. Her realized gain on a sale is $5,000,000.

If she sells, the federal income tax is roughly $250,000 on the depreciation at 25%, $800,000 on the other $4,000,000 at 20%, and $190,000 of 3.8% net investment income tax, about $1,240,000. Paying it shrinks her estate by the same amount, which saves about 40% of it, or roughly $496,000, in estate tax.

If she exchanges and holds until death, the estate is about $1,240,000 larger and pays about $496,000 more estate tax, but the $5,000,000 gain is never taxed because her heirs take a stepped-up basis. The exchange leaves the family about $744,000 ahead.

• Estate tax base: unchanged by the exchange itself.
• Income tax deferred: about $1,240,000, erased at death.
• Net family benefit of exchanging in this example: about $744,000.

A DST changes how the property is held, which can matter for valuation and gifting

A Delaware statutory trust interest is a beneficial interest in a trust that holds real property, and Rev. Rul. 2004-86 lets you acquire one in a 1031 exchange. Its estate tax value is still fair market value under the willing-buyer test, which for a non-controlling interest with transfer limits is an appraisal question rather than a fixed discount.

No IRS ruling or regulation sets a valuation discount for DST interests, so any discount an appraiser applies has to be supported on the facts of that trust. Treat a discount as a possibility to test, not a planning assumption; the broader trade-offs are in DSTs in estate planning.

Fractional interests are also easier to divide than a single building. Where the trust documents permit transfers, smaller pieces can be given over several years against the $19,000 per-recipient annual exclusion for 2026, or split cleanly among heirs; see transferring DST interests to heirs and trusts.

What to do if your estate is near or above the exclusion

Treat the exchange as an income tax tool and handle estate tax separately with your estate attorney. Lifetime gifts, trusts and the marital deduction are the estate tax levers; the exchange simply keeps more of the property's value intact until those plans take effect.

Check liquidity. Estate tax is due in cash, and a portfolio of illiquid trust interests or a single large building may have to be sold to pay it, which is the problem the zero cash flow DST at death page looks at from the heirs' side.