Chapter 16 - § 16.3 • ADJUSTMENTS TO BASIS

• Jurisdiction: Colorado

§ 16.3 • ADJUSTMENTS TO BASIS

Pursuant to I.R.C. § 1014, at death, assets owned by the decedent receive a new income tax basis equal to the value of the assets at the date of the decedent's death. A partnership may elect to adjust the basis of its assets to reflect the new basis of a decedent's partnership interest.²⁶ This election is available to general partnerships, limited partnerships, and LLCs, but it is not available to corporations (whether C or S). Moreover, this election would not be available for an LLC that had elected to be treated as a corporation for tax purposes.

In the case of a single-member LLC that is disregarded for tax purposes,²⁷ the basis adjustment of I.R.C. § 1014 would apply directly to the assets owned by the LLC because, for tax purposes, the assets would be considered as having been owned directly by the decedent. Of course, no discount would be allowed in the case of assets owned by a single-member LLC because the single owner did not have either a minority interest or a lack of liquidity.²⁸

To reflect how the adjustment in basis works, assume that an individual dies owning 50 percent of the stock in a corporation (C or S) that owns as its sole asset highly appreciated real estate (basis of $100x; value at date of death being $1,000x). The value of the corporate stock for federal estate tax purposes will become the new basis of such stock. In the hands of the estate of the deceased 50-percent owner, the new basis would be $500x. There will, however, be no change to the corporation's $100x basis in its assets.

If, instead, the decedent had an interest in an LLC or limited partnership owning the land, the LLC (assuming it is treated as a partnership for federal tax purposes) or limited partnership could elect to increase the basis of its assets to reflect the increase in the basis of the decedent's partnership interest.²⁹ This results in the inside basis of the entity ($100x) being increased to the outside basis (fair market value or $500x in this example) for all partners and members. As a result, the partnership or LLC that elects a step-up in assets will be entitled to greater depreciation and amortization and will not recognize as much gain as would be the case if the election is not made. In instances where there is no estate tax liability, this step-up in basis is often advantageous over having gifted to family members.

However, the basis of both partnership (including LLC) interests and S corporation stock acquired from...