Does "stepped up basis" work the same with property inside an LLC ?

[teachwithgames_com]

My mom has a rental property inside an LLC. The LLC members are her and my deceased father (2017).

They purchased the property in the 80's (~50K), created the LLC in early 2000's.

The property is worth ~$300K now.

How does the cost basis "step-up" in this situation?

TIA, chris

[Anonymous]

an issue.  when the LLC was formed, the IRS says it can't use the qualified joint venture election to escape filing a partnership return. A domestic LLC with at least two members that does not file Form 8832 is classified as a partnership for federal income tax purposes.   so from the year the LLC was formed thru the date in 2017 when your father died a partnership return should have been filed.    at the date of his death the partnership terminated (a partnership can not have a single member)   so for the rest of 2017 assuming your mother inherited your father's interest, the reporting should have been done on her schedule E.   you mother's tax basis in her share would remain the same.  she would get a stepped-up basis in her husband's share.    the basis for depreciation on her share would not change.  since the stepped up basis for her husband's share in the house would get stepped up it should have been depreciated on the stepped-up basis.  

the IRS says depreciation allowed or allowable so if the depreciation wasn't taken on the steeped up basis the IRS says it was for purposes of computing gain. loss, depreciation recapture upon disposition 

so it may be necessary for your mother to amend her 17 and 18 returns to take the correct depreciation

(any depreciation taken on her husband's share while he was alive disappears) .  

[Carl]

The LLC members are her and my deceased father (2017).

That's a big problem. The Multi-member LLC/Partnership ceased to exist on the date of your dad's passing. That's because a partnership "MUST" have two or more members. You can not have a partnership or multi-member LLC with only one member.

The partnership ceased to exist on the date of dad's passing in 2017. So if it was not done in 2017, the 2017 IRS Form 1065-Partnership return needs to be amended and the partnership must be disolved as of the father's date of passing. All assets of the partnership are passed to your mother (the sole survivor of the partnership) on the K-1.  The amending of the 1065 partnership return will result in a corrected K-1 being issued to your mother, showing the transfer of all parntership assets to her.

Then, your mother needs to also amend her 2017 personal 1040 tax return to include the corrected K-1, and to enter the rental property on SCH E on her personal 1040 tax return. When she enters the property on SCH E of her personal 1040 tax return, she will include in the cost of that property asset, the stepped up basis which is 50% of the FMV of the property on the date of your dad's passing.

Once that is done, your mom gets to amend her 2018 tax return. But it's not going to be as simple as importing the new data from the amended 2017 tax return. When you amend a return, importing from the prior year's tax return is just flat out not possible. So she will have to manually enter the rental property one keystroke at a time, along with the total of all depreciation taken in prior years including that increased amount of depreciation she took in 2017, on the stepped up basis. Any carry over losses (and there should be a *lot*) will have to be manually entered also.

Once the 2018 return is amended completely, then (and only then) can she even start her 2019 return. The 2019 return will then be able to import the correct data from the amended 2018 return. Just make *SURE* that you import from the .tax2018 file that is physically on her computer since that will be the amended one.

If you and/or her don't understand how all this stuff works, then you'll find the cost of professional help will seem like a pittance when compared to all the fines, back taxes and penalties that the IRS *will* assess if it's not done right. So professional help with this would probably be the better and less costly way to go for this year.

[tagteam]

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@teachwithgames_com wrote:

How does the cost basis "step-up" in this situation?

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This gets really complicated very quickly and one of the reasons is what passes to heirs (or your mom, as the case may be) is not the rental property, it is your father's interest in the LLC. Thus, included in your father's estate at the time, would be his LLC share which is not even real estate, it is intangible personal property.

Since the LLC owns the real estate (presumably title is in the name of the LLC), an election is typically made - to the best of my recollection, technically termed a Section 754 election - which has the effect of increasing the inside basis of the deceased member's share. 

If the above sounds fuzzy, difficult to understand, or just plain incomprehensible, then that only serves to reinforce the point that you need a tax and/or legal professional for this scenario.

[teachwithgames_com]

Does it change anything that we live in AZ a community property state?

thanks for any help/time on this,

[tagteam · Accepted solution]

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@teachwithgames_com wrote:

Does it change anything that we live in AZ a community property state?

thanks for any help/time on this,

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If an LLC is owned by a married couple as community property in a community property state (and no other person would be considered an owner) and no election has been made to treat the LLC as a corporation, then the LLC is a "qualified entity" and can be treated as a disregarded entity at the discretion of the owners.

See https://www.irs.gov/pub/irs-drop/rp-02-69.pdf

The question here, of course, is how the owners of the LLC have treated it in prior tax years.

[teachwithgames_com]

I have done my parent's taxes for the past ~ten years and did not even know that some of their properties were inside the LLC until a couple of years ago (before dad pasted) when they sold one that was in the LLC.

I will have my mom dig out the taxes that were done outside of TurboTax to see if it was mentioned. What is the form I will be searching for? Or What else should I look for?

Mom is 91 and I am 90 minutes away and sick right now. But we will be working on this ASAP.

thank you for helping us,

[tagteam]

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@teachwithgames_com wrote:

I will have my mom dig out the taxes that were done outside of TurboTax to see if it was mentioned.

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Was title ever actually transferred into the name of the LLC? Look for the deed to the property.

Also, since you prepared their tax returns, how did you report the income and expenses from the property? Did you file a Form 1065, report on Schedule E, or use some other method?

[teachwithgames_com]

I have only done taxes inside of TT. I answered the questions. I am not smart enough to lie on it or even do it any other way.

I just looked at the PDF and there is has always been a schedule E. That is good, correct?

Also, I see on the tax bill that it lists the LLC. Not so good?

Thank you for your patience and education,

[tagteam]

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@teachwithgames_com wrote:

I just looked at the PDF and there is has always been a schedule E. That is good, correct?

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Yes, because you do not have to file a 1065 for the property as a result of the Rev. Proc. I cited earlier (it appears that this was treated as disregarded entity by virtue of filing on Schedule E).

Also, the entire property (both your mother's undivided one-half and your father's one-half) receives a stepped up basis because your parents held the property as community property in a community property state. 

[teachwithgames_com]

To be sure I understand, the cost basis steps up to the value on the date of my dad's death, correct?

[tagteam · Accepted solution]

Yes, that is correct.