Basis Step-Up

A basis step-up occurs when the tax basis of a commercial property is increased to its fair market value due to a taxable acquisition, inheritance, or certain restructuring events. In CRE, this adjustment can reset depreciation schedules and reduce taxable gain on a future sale. For buyers and lenders, a step-up can enhance after-tax cash flow by allowing higher depreciation deductions, but it depends on the nature of the transaction and whether assets are acquired or ownership interests are purchased. Accurate modeling of step-up effects is essential in deal valuation and loan underwriting.

Sponsors, tax advisors, and lenders incorporate basis step-up assumptions when modeling pro forma cash flows after an acquisition or recapitalization. When a buyer purchases assets rather than membership interests, the step-up is typically available and increases depreciation deductions, which can improve net operating income on an after-tax basis. Lenders consider whether the borrowing entity will realize a step-up because it affects borrower coverage ratios and expected tax liabilities on exit. Modeling should reflect the timing and magnitude of step-up and any limitations imposed by tax law or transaction structure.

Basis step-up is important because it can materially change the taxable economics of ownership, alter depreciation allowances, and affect net proceeds at disposition. For acquirers, a step-up can provide valuable tax shelter that improves returns and supports higher leverage or lower required cash yields. For lenders, understanding whether a step-up exists ensures realistic assessments of borrower cash flow and exit taxes. Failure to account for a potential step-up—or wrongly assuming one—can misstate loan risk, borrower solvency under different scenarios, and the viability of refinance or sale strategies.