My spouse died. Should I sell now with the step-up or exchange?

Your new basis decides how much gain is left to defer

Section 1014(a) gives inherited property a basis equal to its fair market value at death. For a surviving spouse, how much of the property is 'inherited' depends on how you held it.

If it was community property, section 1014(b)(6) also resets 'the surviving spouse's one-half share' when at least half was includible in your spouse's estate. IRS Publication 551 says that in the nine community property states 'the total value of the community property, even the part belonging to the surviving spouse, generally becomes the basis of the entire property.'

If you held as joint tenants with right of survivorship or tenants by the entirety, section 2040(b) includes only 'one-half of the value' in your spouse's estate. Your spouse's half resets; your half keeps its old basis and its share of past depreciation. The details of who gets a full or partial reset are in whether 1031 property gets a full step-up.

When the reset leaves little gain, selling is often the simpler path

A sale shortly after a full reset produces gain only for appreciation since the date of death, minus selling costs, and section 1223(9) treats it as long-term even inside a year. An exchange still needs an intermediary, a 45-day identification and a 180-day close, and its benefit is limited to deferring that small gain.

The reset also restarts depreciation, so keeping the property can make sense too: you would depreciate the building again from the new basis. The choice between selling and keeping is then about what you want to own, not about tax.

If the executor is still valuing the estate, note that the alternate valuation date under section 2032 can be elected only if it lowers both the gross estate and the estate tax, so for most estates the date-of-death value is the basis.

When half the gain remains, an exchange can still be worth doing

Joint tenants in common law states keep the original basis on the survivor's half. On a long-held, heavily depreciated rental that half can carry a large gain, taxed up to 25% on the depreciation layer plus 20% on the rest at higher incomes, and the 3.8% net investment income tax above $200,000 of modified AGI for a single filer.

Exchanging defers that gain. If you are tired of managing tenants, a Delaware Statutory Trust is the usual passive replacement: the trust's sponsor and manager run the property, and you receive any distributions the property produces. DST interests are illiquid, distributions are not guaranteed, and fees reduce returns; DSTs for first-time passive investors sets out the trade-offs.

Exchanging again also keeps the remaining gain in line for a reset at your own death, which is the logic in holding for the step-up versus exchanging now.

Worked example: the same rental under two kinds of title

Hypothetical, round numbers; run your own numbers with your CPA. You and your spouse bought a rental for $400,000 that is worth $1,200,000 at your spouse's death, with an adjusted basis of $250,000 after $150,000 of depreciation.

As community property in California, both halves reset and your basis is $1,200,000. Selling for $1,200,000 soon after produces roughly no gain apart from selling costs, so an exchange would defer almost nothing.

As joint tenants in Ohio, your spouse's half resets to $600,000 and your half keeps $125,000, so your basis is $725,000. A $1,200,000 sale produces about $475,000 of gain, of which about $75,000 is your half's depreciation taxed up to 25%. That is a gain worth deferring if you want to stay invested in real estate.

• Community property: basis about $1,200,000, gain near zero.
• Joint tenancy: basis about $725,000, gain about $475,000.
• Either way, the 45-day and 180-day periods run from your sale's closing, not from the date of death.

Sequence the decisions around the deadlines that apply to you

If the property is your former home, section 121(b)(4) lets an unmarried surviving spouse exclude up to $500,000 of gain if the sale 'occurs not later than 2 years after the date of death' and the joint requirements were met just before death, and section 121(d)(2) counts your spouse's ownership and use as yours. Combined with the basis reset, many surviving spouses owe nothing on the home; mixed home and rental situations are in section 121 versus 1031 on a former home.

For the year of death, Publication 559 says the personal representative and surviving spouse can generally file a joint return. If your spouse's estate did not file to elect portability of the unused exclusion, Rev. Proc. 2022-32 allows a simplified late election 'on or before the fifth anniversary of the decedent's date of death'; see portability of the estate exemption.

Get a date-of-death appraisal before you list anything, because it fixes your basis whichever way you go.