Trustee of grantor trust holding partnership interest died during the tax year. How to prepare k-1s?

[NotAnExpert]

My parents have an LLC for rental property that files a 1065 partnership return. Both held interests through revocable trusts; however, Dad (1% interest) passed away during the year so I understand that his trust becomes irrevocable on the date of his death and requires an EIN which we have. However, I'm unsure what happens with the income (loss) for the year and his capital account. I presume the LLC will have 3 K-1s - one for mom, one for dad's revocable trust, and one for his irrevocable trust? Does the income (loss) get split pro-rata between the revocable and irrevocable trusts? Is the interest deemed to be transferred to a new partner? What goes on the K-1 capital rollforward for each partner and what are the implications for the revocable trust - gain or loss on the transfer? Thanks!

[Critter-3]

Seek local professional assistance to prepare a return in this awkward situation. Hopefully the partnership is on extension ... if not it is really late ... if it is then it is due in 2 weeks. 

[Anonymous]

consult a pro.  without knowing the provisions of his trust we can't tell you who inherits his interest. it could be the trust or it could be his spouse or it could be someone else. 

there are various filings that the partnership must do so the heir gets the benefit of the step-up in basis - election under 754 to apply the provisions of IRC sections 734(b) and 743(b).  in some rare instances, this may not want to be elected. 

income gets allocated for his interest based on the number of days he was alive.  but the heir then may reduce their share of income or loss if electing basis adjustment.  a pro can look at everything to give the best advice. 

[NotAnExpert]

Thanks for the input, @Anonymous & @Critter-3 . Mom is hoping not to hire this out since dad's share was only 1% of the partnership and not significant in value, though may have to resign to doing so.

With respect to the trust, the trust held the 1% interest prior to grantor's death and there is no provision specifically enumerated for the LLC interest in the trust agreement or the LLC operating agreement. Mom becomes the successor trustee and has discretion to administer assets for benefit of herself and their children. So I believe the trust still holds the LLC interest with mom as successor trustee. 

With respect to the partnership, not electing 754 as it's not material, and her plan is to liquidate the trust and partnership interest. 

Does that simplify things hopefully? Thanks for the guidance on pro rata allocation of income (loss). So that leaves the question regarding the LLC interest being held by the revocable trust and subsequently the irrevocable trust after the grantor's death. How is that "transfer" treated and reported on the 1065? Is that a question that can be answered based on the facts stated above?

[Anonymous_]

@NotAnExpert 

You have presented a somewhat complex scenario which would require a thorough reading of the trust document itself as well as the partnership agreement. Professional guidance is virtually a must in this situation and, although it is understandable that the value is not significant, the potential ramifications are significant if the issues are not handled properly. Further, facts need to be filled in accordingly.

For example, you stated that your dad's share of the partnership was 1% (which he held in presumably his revocable trust?) but you did not state if your mom held the other 99% or whether there are other partners. Obviously, if your mom was the only other partner and the agreement did not dictate otherwise, the partnership would have ended upon the passing of your dad and the 1065 would so reflect (e.g., final return filed and final K-1s issued).

[NotAnExpert]

Thanks, @Anonymous_. Yeah, I'd hoped this was not too unusual with a revocable trust owning an interest in a family partnership, but given my inability to find much direction on point I am finding you are correct regarding the complexity of the scenario. 

To answer your questions - Sorry I neglected to mention, but yes, Mom owns the other 99% through her revocable trust, and Dad owned 1% in his revocable trust. From what I can tell, though, the partnership does not immediately end upon his passing.  The operating agreement from the LLC indicates that upon the death of a member, the trustee has all the rights of a member for the limited purpose of settling out the member's estate and that the substitution of a trustee does not cause a member to cease as a member.  As for the tax partnership, I think the trust remains a partner until the partnership is liquidated. IRS Publication 541 mentions "For income tax purposes, a retiring partner or successor in interest of a deceased partner is treated as a partner until his or her interest in the partnership has been completely liquidated." (https://www.irs.gov/pub/irs-pdf/p541.pdf pg 12)

Is that the case even if the substitute trustee and ultimate beneficiary is the same person as the 99% partner? 

[Anonymous_]

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@NotAnExpert wrote:

Is that the case even if the substitute trustee and ultimate beneficiary is the same person as the 99% partner? 

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Yes, the trust can be a member of an LLC (apparently, the operating agreement was drafted to take the revocable trusts into consideration). 

However, prior to your dad's passing, his trust was a grantor trust and, as such, he was treated as the owner of the assets contained within the trust (as grantor). After his passing, the trust technically became the owner of the assets, including the interest in the LLC (since it was presumably held in the name of the grantor trust). As a result, the LLC has a different member (i.e., the irrevocable trust itself).

[Critter-3]

Filing a partnership return with a change in partners mid year is not for the DIY filer ... professional assistance should be employed for at least this return. 

[NotAnExpert]

Yup. So we've filed the partnership returns in the past with the grantor as the member, and I now have an EIN for the irrevocable trust member post-death. Just unsure how that "transfer" from the grantor (revocable) to the trust (irrevocable) is viewed for tax purposes - i.e. is it treated as a sale that triggers gain for the grantor? 

@Critter-3 yeah, it's coming around to that.  Just hoping to work out as much as we can on our own at this point.

[Anonymous_]

It is not a sale. Technically, the trust acquires the interest from the decedent and, as per Section 1014, that generally results in the acquirer (the trust in this instance) taking a stepped up basis. Income would be allocated based upon the date of the decedent's death.

Again, this is way beyond a DIY scenario as has been mentioned several times in this thread. Please seek guidance, in person, from a local tax and/or legal professional.

[Rick19744]

You have received some good high level advice, but I will also add once again that you should seek some professional advice.

Just receiving bits and pieces of information is not the same as being able to read the entire trust document and LLC operating agreement.

As has been noted, the initial trust (grantor trust) will receive an allocation to the date of death.  You will then have a separate K-1 for the remaining allocation for what is now the trust for the estate.  This K-1 will use the new EIN you just received.  This is now a separate trust return.

Having said that, without reading the provisions of the trust document, how this 1% gets handled hinges on that language.  It may go to the estate trust until a specific act occurs, or it may just go directly to your mom.  

It may be a marital trust or a credit shelter trust.  While not likely, but possible, we just don't know without reading the trust provisions.

Other than this high level input, we can't really be of more assistance.

[NotAnExpert]

Thanks to all for everyone's help! We will be seeking professional advice.