Real estate held until death gets treated very differently than real estate sold during life. The federal estate tax applies to the value of everything a person owns at death above the exemption threshold, but property that passes to heirs also receives a step-up in basis to fair market value, which means decades of unrealized capital gain and depreciation recapture can simply disappear for income tax purposes. Those two facts pull a Detroit property owner's planning in different directions depending on the size of the estate.
Why the Step-Up Changes the Calculus
An owner who has held a rental or commercial building for decades and depreciated it heavily may be sitting on a large built-in gain that would trigger significant tax if sold today. If that same property is instead held until death, the heirs inherit it at its current fair market value as their new basis, and the built-in gain along with the depreciation recapture is never taxed as income to anyone. This is one of the most direct ways real estate defers, and in some cases permanently avoids, capital gains tax, though it requires holding the asset rather than selling it.
Where the Federal Estate Exemption Actually Bites
The federal estate and gift tax exemption is large enough that most individual estates never owe federal estate tax, but a Detroit-area owner with substantial commercial real estate holdings, especially combined with other assets, can be closer to that threshold than expected. Michigan does not impose its own separate estate tax, but the federal exemption amount is scheduled to change and has moved before, so an estate that looks comfortably under the line today is not guaranteed to stay there without periodic review.
Holding Until Death Versus Exchanging Now
An owner who wants to reduce day-to-day management, consolidate several small properties into one, or move into a different property type does not have to choose between the step-up and staying invested. A 1031 exchange defers the capital gain during life by moving proceeds into replacement investment property through a qualified intermediary, and the replacement property can still receive the step-up in basis if it is held until death. Exchanging and eventually holding until death are not mutually exclusive strategies; many estate plans for real estate investors use both in sequence.
Where This Intersects With Estate Liquidity
An estate heavy in real estate and light on cash can face a liquidity problem even without an estate tax bill, since heirs may need to sell property to pay administrative costs, other taxes, or simply to divide the estate among multiple beneficiaries who do not all want to hold real estate together. Planning that considers whether heirs will want to keep, sell, or exchange inherited property, and whether the estate has cash outside real estate to cover near-term costs, tends to prevent a rushed sale immediately after death.
Bringing an Estate Attorney and CPA Into the Same Conversation
Estate tax exposure, basis step-up, and any lifetime exchanges an owner is considering all interact, and a plan built by an estate attorney without input from a CPA familiar with the real estate history, or the reverse, tends to miss something. Pulling current appraisals, depreciation schedules, and the estate's overall asset mix together before deciding whether to sell, exchange, or hold a property gives both advisors what they need to model the actual outcome.
Common 1031 Exchange Questions
Does Michigan have its own estate tax?
No, Michigan does not impose a separate state estate tax, so real estate held in Michigan is generally subject only to the federal estate tax rules for estates above the federal exemption threshold.
What is the step-up in basis and how does it apply to real estate?
When a property passes to heirs at death, its cost basis resets to fair market value on the date of death, which generally erases the built-in capital gain and depreciation recapture that existed before death for income tax purposes.
Can I still do a 1031 exchange if I am planning my estate around the step-up?
Yes, exchanging during life to defer capital gains and holding the replacement property until death are compatible strategies, since the replacement property can still receive the step-up in basis when it eventually passes to heirs.
Does an exchange reduce my taxable estate?
An exchange defers income tax on the gain but does not by itself reduce the value included in a taxable estate, since the replacement property's fair market value is what counts for estate tax purposes, not its basis.
Should heirs sell an inherited property or hold it?
That depends on the heirs' goals, the property's condition, and whether multiple beneficiaries want to hold real estate jointly. A CPA can model the tax consequences of selling against holding using the newly stepped-up basis before a decision is made.
