Adjusting outside basis of inherited partnership interest

[attykss1]

I received my interest in a commercial real estate LLC through inheritance in 1990.  Per my father's estate tax return, the FMV was the LLC interest was $104,000.  The LLC interest was put into a bypass trust for my mother, who received a stepped up basis in the LLC and all income from the LLC until her death in 1999.  I do not have a stepped up basis because the LLC was in a bypass trust and was not part of my mother's estate.  My first K1 for the LLC used my mother's ending capital account balance as my beginning capital account balance.  That amount was about $50,000 less than my own outside basis.  My question is can I use my own outside basis ($104,000) as a starting point for making my initial outside basis adjustment (for year 1999) or is my outside basis reduced by income distributions made to my mother during the time the LLC was in the bypass trust? 

[M-MTax]

I'd say it's reduced by the income distributions for the time it was in the bypass trust......don't see any way around that since it was not part of her estate and doesn't get a step up.

[Rick19744 · Accepted solution]

This question is complicated and since we don't have access to reading the actual language in the trust(s), it is hard to provide a completely accurate answer.

In these situations, a bypass trust is really two trusts that are set up upon the death of a spouse; there is the marital trust and then the "bypass trust" or it could be called a credit shelter trust (these are the A and B trusts). This bypass trust, or B trust, is an irrevocable trust.  Depending on how this is set up, it may or may not be a grantor trust while your mom was living.  Regardless, if your Dad owned the LLC interest, then at this point in time, that interest would be stepped up.  It would then be adjusted annually for the applicable K-1 line items.

Your interest when that LLC interest is distributed out of the  bypass trust, will be the tax basis at that point in time; which should have already included the original step-up.

Keep in mind, the change to having to reflect tax capital account reporting for 2020 partnership and LLC's taxed as a partnership will not always be accurate.  The individuals preparing these 1065's don't always have all the information available to accurately determine the beginning balance.

Also keep in mind, that this figure on the 1065 K-1 item L, is only a tax capital account number.  It is not your tax basis.

You may want to sit down with a tax professional to make sure you know your outside tax basis beginning point.

[attykss1]

Rick:  thank you for your reply.  I have reviewed the trust document and it appears that during his lifetime, my father had broad powers over the assets in the credit shelter trust.  For that reason, I think this is a grantor trust.  

The interest in the LLC was a community property interest.  When you said in your reply "if your dad owned the LLC interest, then at this point in time, that interest would be stepped up."  Not sure what you mean by "at this point in time".  Am I correct in thinking that your answer means that the adjustments I need to make on a annual basis to my outside basis in the LLC for purposes of determining how much I can deduct of ordinary business losses from the LLC would not be the FMV of my father's LLC interest when he died, but rather the amount of that interest reduced by income distributions to my mother until her death?