The 721 exchange's estate-planning power culminates with the heirs — those who inherit the OP units held until death. While much is written about the owner's perspective (deferring the gain during life), the heirs' perspective is equally important and reassuring: they inherit the OP units with a stepped-up basis, which can erase the deferred gain entirely. This means the heirs receive the units valued at the date-of-death fair market value, and can convert them to REIT shares or sell with little or no income tax on the prior appreciation. The units also divide cleanly among multiple heirs. Understanding the heirs' perspective — what they inherit, how the step-up benefits them, their options, and how the units divide — helps owners plan and reassure their families. This guide explains 721 exchanges and the step-up in basis for heirs.
What heirs inherit
When an owner holds OP units until death, the heirs inherit the units — their stake in the REIT's operating partnership, carrying distributions, convertibility to REIT shares, and the underlying real estate exposure. So the heirs receive the OP units themselves, becoming the new holders (partners in the operating partnership), with all the rights the units carry.
Critically, the heirs inherit the units with a stepped-up basis — their basis in the units is reset to the fair market value at the owner's death, not the owner's old (low, carried-over) basis. So the heirs don't inherit the owner's embedded deferred gain (which the low basis represented); instead, they get a fresh basis at the current value, erasing that gain. This is the key feature of what they inherit.
So the heirs inherit valuable OP units (income-producing, convertible) with a stepped-up basis that erases the deferred gain — a favorable inheritance. They receive the units' full current value with a clean (stepped-up) basis. What heirs inherit — the OP units (income-producing, convertible, carrying the real estate exposure) with a stepped-up basis (reset to date-of-death value, erasing the deferred gain) — is a favorable inheritance. The heirs get the units at current value with a clean basis. Understanding what heirs inherit sets up how the step-up benefits them. Heirs inherit valuable, income-producing OP units with a stepped-up basis that erases the deferred gain, a favorable outcome the 721 exchange's estate planning produces.
How the step-up works for heirs
The step-up works for the heirs by resetting their basis in the inherited units to the fair market value at the date of the owner's death. Under the general step-up rule for inherited property, property included in a decedent's estate gets a basis equal to its date-of-death value. So the heirs' basis in the OP units becomes the units' value at the owner's death, erasing the difference from the owner's low basis (which was the deferred gain).
The practical effect for the heirs is that they can convert or sell the units with little or no income tax on the prior appreciation. Because their basis is the current (stepped-up) value, converting the units to REIT shares (or selling) shortly after inheriting produces little gain — the gain that would have been recognized (the owner's deferred gain plus appreciation) is erased by the step-up. So the heirs avoid the income tax the owner had deferred.
This means the heirs can access the units' value (by converting and selling) without the income tax burden the owner had been carrying. The step-up effectively passes the units to the heirs free of the deferred income tax. How the step-up works for heirs — resetting their basis to the date-of-death value, so they can convert or sell with little or no income tax on the prior appreciation — is the mechanism that benefits the heirs. The step-up erases the deferred gain for them. Understanding how the step-up works for heirs shows their favorable tax position. The step-up lets heirs access the units' value free of the deferred income tax, the key benefit for the next generation.
Heirs inherit OP units with a basis stepped up to the date-of-death value — so they can convert or sell with little or no income tax on the prior appreciation the owner had deferred.
Heirs' options after inheriting
After inheriting the OP units (with the stepped-up basis), the heirs have several options. They can hold the units — continuing to earn distributions (income) and retaining the real estate exposure, just as the owner did. So an heir who wants the income and investment can simply hold the inherited units, enjoying the distributions.
They can convert the units to REIT shares — and because of the step-up, this produces little gain (the deferred gain is erased), so they can convert with minimal tax. After converting to shares (for a public REIT), they can sell the shares for cash. So an heir who wants liquidity can convert and sell with little tax, accessing the value. Or they can hold the shares for the REIT investment.
They can sell or redeem to realize the value — converting and selling (or redeeming, where available) to get cash, with the step-up minimizing the tax. So the heirs have flexibility: hold for income, convert for liquidity, or sell, each with the step-up making the tax minimal. Heirs' options after inheriting — holding for income, converting to REIT shares (with little tax due to the step-up), or selling/redeeming for cash — give the heirs flexibility, with the step-up minimizing the tax on whatever they choose. The heirs can access the value or keep the investment. Understanding the heirs' options shows their flexibility. Heirs can hold, convert, or sell their inherited units with the step-up minimizing the tax, giving them flexible, tax-efficient access to the inheritance.
Dividing among multiple heirs
A major practical benefit for families is that OP units divide cleanly among multiple heirs, unlike a single property. The owner can bequeath specific numbers of units to each heir, so each heir receives their own portion of the units (with the stepped-up basis). This avoids the difficulty of dividing a single property among multiple heirs (which often forces a sale or creates shared ownership).
Each heir, receiving their own units, can independently decide what to do — hold for income, convert for liquidity, or sell — without being entangled with the other heirs in a shared property. So one heir might hold their units (for income) while another converts and sells theirs (for cash), each managing their own portion independently. This independence avoids the conflicts that shared property ownership among heirs can create.
So the divisibility of OP units solves a common estate challenge — fairly and cleanly dividing real estate wealth among multiple heirs, with each heir getting their own manageable, step-up-eligible portion. Dividing among multiple heirs — the OP units dividing cleanly (each heir receiving their own stepped-up units to manage independently), avoiding the difficulty of dividing a single property — is a major practical benefit for families. The divisibility lets each heir manage their own portion. Understanding the divisibility shows how the 721 exchange eases the estate transfer for families with multiple heirs. The clean division of OP units among heirs, each with their own step-up-eligible portion, solves the challenge of dividing real estate wealth, a key family benefit.
The estate tax consideration
While the step-up addresses income tax (the deferred gain), it's important for owners and heirs to understand that estate tax is a separate consideration. Estate tax is a tax on the value of the decedent's estate (including the OP units), which may apply depending on the estate's size relative to the estate-tax exemption. So the OP units' value is included in the estate for estate-tax purposes, like other assets.
The step-up (income tax) and estate tax are distinct: the step-up erases the income tax on the deferred gain (for the heirs), but the units' value may still be subject to estate tax (if the estate exceeds the exemption). So a large estate including OP units might owe estate tax on the units' value, even though the step-up eliminates the income tax on the gain. These are separate taxes.
Estate-tax planning (using exemptions, trusts, gifting strategies, etc.) is a separate matter from the step-up, handled by the estate attorney. So owners should plan for both — the income-tax benefit (the step-up) and any estate-tax exposure — with their estate professionals. The estate tax consideration — the OP units' value being subject to estate tax (separate from the income-tax step-up), which may apply depending on the estate's size, requiring separate estate-tax planning — is important for owners and heirs to understand. The step-up addresses income tax, not estate tax. Understanding the estate tax consideration ensures owners plan for both. The step-up eliminates the income tax on the deferred gain, but estate tax (if applicable) is a separate consideration requiring its own planning with the estate attorney.
- Heirs inherit the OP units with a stepped-up basis (reset to date-of-death value), erasing the owner's deferred gain.
- The step-up lets heirs convert or sell with little or no income tax on the prior appreciation.
- Heirs can hold for income, convert for liquidity, or sell — each with the step-up minimizing the tax.
- OP units divide cleanly among multiple heirs (each managing their own portion); estate tax is a separate consideration from the income-tax step-up.
Communicating the plan to heirs
Because the 721 exchange's estate benefits involve the heirs, communicating the plan to them helps ensure a smooth transition. Owners who do a 721 exchange for estate planning should consider explaining to their heirs what they'll inherit (the OP units), how the step-up benefits them (erasing the deferred gain), and their options (hold, convert, sell). This understanding helps the heirs appreciate and manage their inheritance.
Communicating the plan also lets the owner coordinate with the heirs and the estate professionals — ensuring the heirs know to work with the CPA and advisors on the inheritance (the step-up, the K-1 reporting, their options). So the heirs are prepared to handle the OP units when they inherit them, rather than being confused by an unfamiliar asset.
The communication can be part of broader estate-planning discussions, integrating the 721 exchange and the OP units into the family's understanding of the estate plan. So owners benefit from communicating the 721 exchange plan to their heirs, ensuring a smooth, understood transition. Communicating the plan to heirs — explaining what they'll inherit (the OP units), how the step-up benefits them, and their options, integrated into broader estate discussions — helps ensure a smooth transition and prepared heirs. The communication readies the heirs for their inheritance. Understanding the value of communicating the plan helps owners prepare their families. Communicating the 721 exchange plan to heirs ensures they understand and can manage their inheritance, a valuable part of the estate planning.
How Baker 1031 helps with the step-up for heirs
Baker 1031 Investments helps owners plan the 721 exchange's step-up benefit for their heirs — explaining what the heirs will inherit (the OP units with the stepped-up basis), how the step-up benefits them, their options, and the divisibility among multiple heirs, and coordinating with the estate attorney on the overall plan (including the separate estate-tax considerations). We help owners structure and communicate the plan for their heirs' benefit.
REIT units and related securities are offered through the broker-dealer, Aurora Securities, Inc. (member FINRA/SIPC), and any recommendation follows a suitability review. We don't provide tax or legal advice (your CPA and estate attorney handle the step-up, estate tax, and the heirs' tax); we help you understand the step-up's benefit for your heirs and coordinate the 721 exchange within your estate plan. Our role is to help you use the 721 exchange to pass valuable, income-producing OP units to your heirs with a stepped-up basis that erases the deferred gain — a favorable, divisible inheritance — integrated into your estate plan with your professionals. The step-up for heirs is the culmination of the 721 exchange's estate planning, and we help you plan it for your family's benefit, when we can assist alongside your estate professionals.
Frequently Asked Questions
What do my heirs inherit from a 721 exchange?
The OP units — their stake in the REIT's operating partnership, carrying distributions (income), convertibility to REIT shares, and the underlying real estate exposure — with a stepped-up basis (reset to the fair market value at your death). So the heirs receive valuable, income-producing units with a clean basis that erases your deferred gain. They become the new holders (partners), able to hold for income, convert for liquidity, or sell, with the step-up minimizing the tax. It's a favorable, divisible inheritance the 721 exchange's estate planning produces.
How does the step-up benefit my heirs?
The step-up resets the heirs' basis in the inherited units to the date-of-death value, erasing your deferred gain. So the heirs can convert or sell the units with little or no income tax on the prior appreciation — the gain you had deferred is erased for them. They avoid the income tax you'd been carrying. So the step-up lets your heirs access the units' value (by converting and selling) or keep the investment, free of the deferred income tax — the key benefit for the next generation, passing your real estate wealth to them tax-efficiently.
What can my heirs do with the inherited units?
They can hold the units (earning distributions, retaining the investment), convert them to REIT shares (with little tax due to the step-up, then hold or sell the shares for cash), or sell/redeem to realize the value (with the step-up minimizing the tax). So the heirs have flexibility — hold for income, convert for liquidity, or sell — each with the step-up making the tax minimal. They can access the value or keep the investment as they prefer. The step-up gives them flexible, tax-efficient access to whatever they choose to do with the inheritance.
Do OP units divide among multiple heirs?
Yes — OP units divide cleanly, unlike a single property. You can bequeath specific numbers of units to each heir, so each receives their own portion (with the stepped-up basis). Each heir then independently decides what to do (hold, convert, sell) without being entangled with the others in a shared property. So one heir might hold for income while another converts and sells, each managing their own portion. This divisibility avoids the conflicts shared property ownership among heirs can create, solving the challenge of dividing real estate wealth among multiple heirs.
Will my heirs owe income tax on the inherited units?
Generally little or none on the prior appreciation, thanks to the step-up — their basis is reset to the date-of-death value, so converting or selling shortly after inheriting produces little gain (the deferred gain is erased). They would owe tax only on appreciation after they inherit (if the units rise in value before they sell), and on the income (distributions) they earn while holding. So the prior deferred gain is erased by the step-up, and the heirs owe income tax only on post-inheritance appreciation and ongoing income — a favorable position. Their CPA handles their tax.
Does the step-up eliminate all taxes for my heirs?
It eliminates the income tax on the deferred gain (the prior appreciation), but estate tax is a separate consideration — the units' value is included in your estate for estate-tax purposes, which may apply depending on your estate's size relative to the exemption. So the step-up addresses income tax (erasing the deferred gain), but a large estate might owe estate tax on the units' value. These are distinct taxes. Estate-tax planning (exemptions, trusts, gifting) is separate, handled by your estate attorney. So the step-up eliminates the income tax on the gain, but not necessarily estate tax.
What is the difference between the step-up and estate tax?
The step-up addresses income tax — it resets the heirs' basis, erasing the deferred gain (the prior appreciation) so they don't owe income tax on it. Estate tax is a separate tax on the value of your estate (including the units), which may apply if your estate exceeds the exemption. So the step-up erases the income tax on the gain (benefiting the heirs), while estate tax (if applicable) is a tax on the estate's value. A large estate might owe estate tax on the units even though the step-up eliminates the income tax. They're distinct, requiring separate planning — the step-up is automatic, estate tax needs planning.
Should I tell my heirs about the 721 exchange plan?
Yes, it's often valuable — communicating the plan helps your heirs understand what they'll inherit (the OP units), how the step-up benefits them, and their options, so they're prepared to manage the inheritance rather than confused by an unfamiliar asset. It also lets you coordinate with them and your estate professionals (ensuring they'll work with the CPA and advisors). So explaining the plan, as part of broader estate discussions, helps ensure a smooth, understood transition. Prepared heirs can better appreciate and manage their inheritance, making the communication a valuable part of the estate planning.
What if I want my heirs to keep the units long-term?
They can — heirs who want the investment can hold the inherited units (with the stepped-up basis), earning distributions and retaining the real estate exposure, just as you did. The step-up gives them a fresh basis, and they can hold the units long-term for income and any further appreciation. So if you want your heirs to continue the investment, they can hold the units indefinitely. Communicating this intention (and the units' value) to them helps. The step-up doesn't require them to sell; it just gives them a clean basis, so they can hold or access the value as they choose.
Is the step-up for OP units the same as for other inherited assets?
Yes, generally — the step-up in basis at death applies to OP units as to other inherited capital assets, resetting the basis to the date-of-death value. So OP units receive the same favorable step-up treatment as other inherited property (real estate, stocks, etc.), erasing the embedded gain for the heirs. This is why OP units are an effective estate-planning holding — they qualify for the step-up like other assets, while also being income-producing and divisible. So the step-up for OP units works like the step-up for other inherited assets, a standard and powerful estate benefit under current law.
How does Baker 1031 help with the step-up for heirs?
We help you plan the 721 exchange's step-up benefit for your heirs — explaining what they'll inherit (the OP units with the stepped-up basis), how the step-up benefits them, their options, and the divisibility, and coordinating with your estate attorney on the overall plan (including estate-tax considerations). REIT units are offered through the broker-dealer (Aurora Securities, member FINRA/SIPC) after a suitability review. We don't provide tax or legal advice (your CPA and estate attorney handle the step-up and estate tax); we help you understand and plan the step-up's benefit for your heirs, integrated into your estate plan, so you can pass your real estate wealth to them tax-efficiently.
Do my heirs need to act quickly after inheriting the units?
Not necessarily — heirs can take their time deciding what to do with inherited OP units. The step-up gives them a fresh basis at the date-of-death value, so they can hold the units (earning distributions), convert and sell when ready, or sell over time, without urgency. However, if they plan to sell, doing so relatively soon after inheriting (while the value is close to the stepped-up basis) minimizes any additional gain. But there's generally no requirement to act immediately. Heirs should consult their own CPA and advisors to decide how to manage the inheritance based on their needs. So they have flexibility, not urgency.
What if I gift OP units during my life instead of at death?
Gifting OP units during your life is different from passing them at death — gifts don't receive the step-up (the recipient generally takes your carryover basis, with the deferred gain intact), whereas units held until death get the step-up (erasing the gain). So gifting during life forgoes the step-up benefit. Gifting may have other estate-planning purposes (e.g., removing future appreciation from your estate for estate-tax purposes), but it sacrifices the income-tax step-up. So whether to gift during life or hold until death involves trade-offs between estate tax and the income-tax step-up, which your estate attorney and CPA help you weigh. Holding until death preserves the step-up.
Does the step-up apply if units are held in a trust?
It depends on the trust structure — assets included in your estate at death (such as those in a revocable living trust) generally receive the step-up, while assets in certain irrevocable trusts (outside your estate) may not. So whether OP units in a trust get the step-up depends on whether the trust causes them to be included in your estate. This is a nuanced estate-planning matter, so the trust structure should be designed (with your estate attorney) to achieve your step-up and estate-tax goals. So OP units can receive the step-up in appropriate trust structures, but the specifics depend on the trust, warranting careful estate planning.
Glossary
- Step-Up in Basis
- The reset of the heirs' basis to date-of-death value, erasing the gain.
- Heirs
- Those who inherit the OP units, benefiting from the step-up.
- Date-of-Death Value
- The fair market value at death, the heirs' new basis.
- Deferred Gain
- The owner's untaxed gain, erased for heirs by the step-up.
- Carryover Basis
- The owner's low basis, replaced by the step-up for heirs.
- OP Units
- The inherited interest, income-producing and convertible.
- Divisibility
- The clean division of units among multiple heirs.
- Conversion
- Heirs exchanging units for shares, with little tax due to the step-up.
- Distributions
- The income heirs earn holding the inherited units.
- Estate Tax
- A separate tax on the estate's value, distinct from the step-up.
- Estate-Tax Exemption
- The threshold below which estate tax doesn't apply.
- Section 1014
- The code section providing the step-up in basis at death.
- Income Tax
- The tax the step-up eliminates on the deferred gain for heirs.
- Independent Management
- Each heir managing their own units after dividing.
- Wealth Transfer
- Passing the units to heirs, eased by the step-up and divisibility.
- Communication
- Explaining the plan to heirs for a smooth transition.
Sources & References
- Cornell Legal Information Institute. 26 U.S. Code § 1014 — Basis of property acquired from a decedent
- IRS. Estate and Gift Taxes
- Cornell Legal Information Institute. 26 U.S. Code § 721 — Nonrecognition of gain or loss on contribution
- IRS. Publication 559, Survivors, Executors, and Administrators
Disclosures
This article is published by Baker 1031 Investments, LLC for general educational purposes for accredited investors and is not an offer to sell or a solicitation of an offer to buy any security, nor is it tax, legal, accounting, or investment advice or a recommendation. Any securities offering is made solely through a sponsor’s private placement memorandum (PPM) following a suitability determination. Securities offered through Aurora Securities, Inc. (ASI), member FINRA / SIPC; Baker 1031 Investments is independent of ASI.
Oil & gas mineral and royalty interests and DST programs are speculative, illiquid securities sold only to verified accredited investors and involve substantial risk, including possible loss of principal, commodity-price and production-decline risk, lack of control, and the risk that an intended 1031 exchange fails to qualify for tax deferral. Whether a particular interest qualifies as like-kind real property is a fact-specific legal determination that varies by state and by the terms of the instrument. Tax results depend on your individual circumstances. Consult your own CPA and attorney before acting. Past performance does not guarantee future results.
