allocation of step up in basis to inherited interest in commercial real estate LLC

[attykss1]

I inherited an interest in a commercial real estate LLC that owned 3 properties.  Per the estate tax return (which was filed and accepted by the IRS), the FMV of inherited interest was $90,000.  The return did not provide a separate analysis of the FMV of each property.  In 2008, the LLC sold one of the properties.  When I filed my 1040, I did not allocate any of the step up to that property.  In 2022, the LLC sold the 2nd property.  Can I apply  $45,000 of the step up when calculating my net gain on the sale of the 2nd property or has the portion that should have been used for the sale of the 1st property been lost?

[Anonymous_]

I am going to page @Rick19744 since he is intimately familiar with basis and distributions with respect to partnerships and S corporations, which are pass-through entities with their own set of rules.

However, there is a threshold question:

Is the LLC you inherited a single-member LLC or multiple-member LLC?

[Rick19744]

It would be good to understand the response to @Anonymous_ question.

In addition, depending on the response to the above question, if this is a multi-member LLC, was a section 754 election made at the time of inheritance?

[attykss1]

multi-member LLC

[attykss1]

some LLC had section 754 deductions prior to the year I inherited my interest but a section 754 was not applied by the LLC's CPA to my inherited interest.  

[attykss1]

one member of the LLC had a section 754 made at the time of inheritance and his section 754 deduction was included in his K-1 for the year I inherited my interest.  I inherited my interest from my mother who died in May 1999.  In refusing to  apply section 754 to my inherited interest, the CPA relied on IRS section 743(1(k)(20(ii) which required written notice by the transferee, and apparently, the estate's executor did not provide the required notice.   The final regs were not issued at the time my mother died.  So I think the CPA was wrong.

In any event, when the 1st property was sold, I did not adjust my outside basis to include any part of the step up.   

[Rick19744]

The additional information is helpful.

• Well......you have bad news and quasi good news; in that order.
• Obviously I don't have the details of the situation at the time of the inheritance, or whether the CPA understood what transpired.  It appears, based on the limited facts, that the CPA did know that the transfer occurred, and could have easily taken care of this at the LLC level had they wanted to; but once again, I don't know the timing of all the events.  The cite is Regulation 1.743-1(k)(2)(ii) with respect to the reporting information to the LLC.
• So the bad news is that since no election was made at that time, there is a timing difference between inside basis and your outside tax basis.
• As a result of this, you will not get any benefit of the step-up until you exit the LLC.  This is the quasi good news portion, because while there was no inside basis adjustment (no Section 754 election made for you with a Section 743 adjustment), your outside tax basis was stepped up, as the starting point for your outside tax basis was the FMV at date of death.
• Had there been an inside basis step-up, this timing difference would have decreased over the years for each property and you would have had a different inside basis for each property, resulting in a different gain or loss when a property was sold.
• At this point it is water over the dam.  You don't lose out on anything, it is just a matter that the timing of any benefit is longer than expected or desired.

[attykss1]

Rick:  thank you so much for your comprehensive reply.  Just so I understand your comments, when I report the sale of property 2 on schedule 4797, in box G, do I use the number from the K-1, line 10 which doesn't include the step up.  FYI, that's what I did for the sale of property 1 in 2008.  Karen

[Rick19744]

Yes.  

If there had been a Section 754 election and 743 adjustment for your interest, you would have had something separately reported to you on the K-1.

[attykss1]

Good to know I did things correctly in 2008.  Bad to know that I am going to pay a large amount of tax in 2022.  I have one followup question.  The LLC has 9 members.  3, including me, did have section 754 adjustments or whatever the correct term is, but the other 6 did.  On the LLC's form 4797, does box e have to be calculated differently for those and have and do not have 754 adjustments?  Same question re box f.  The current CPA for the LLC has not factored that in.  

Your help has been really valuable.  Thank you again

[Rick19744]

Any member that would have had a Section 754 election and Section 743 adjustment made for inside basis, would have a separately computed figure on their specific K-1.  These adjustments are specific to the member, and as a result, are only reflected on their individual K-1.

[Rick19744]

@attykss1 

If you could correct your previous question where it mentions all 9 members that would be helpful for others that may read this.  Currently it reads that all 9 had the Section 754 and that doesn't seem to be correct.

Thanks

[attykss1]

correction:  the LLC has 9 members.  6 have section 754 adjustments.  3 do not have section 754 adjustments

[Rick19744]

Thanks for the update clarification.