Does Property in an LLC Get a Stepped-Up Basis?

Property held in an LLC can get a stepped-up basis when the owner dies, but whether it actually does depends on how the IRS taxes the LLC. A single-member LLC gives heirs the step-up automatically. A multi-member LLC taxed as a partnership can pass it through, but only if the partnership files a Section 754 election on time. An LLC taxed as a C corporation or S corporation generally cannot pass a step-up through to the assets inside it. The classification you never think about while alive controls whether your heirs inherit hundreds of thousands in tax savings or a bill for gains that built up during your lifetime.

What a Stepped-Up Basis Actually Does

Basis is the number the IRS subtracts from your sale price to figure taxable gain. Buy a rental for $200,000, sell it for $500,000, and you have $300,000 of gain. When the owner dies, most property they held gets a new basis equal to its fair market value on the date of death.1Office of the Law Revision Counsel. 26 USC 1014 – Basis of Property Acquired From a Decedent That $200,000 property, worth $500,000 at death, gives the heir a $500,000 basis. Sell for $500,000 the next month and the taxable gain is zero.

The reset also erases accumulated depreciation. If the decedent had claimed $150,000 in depreciation deductions during their lifetime, a normal sale would trigger recapture as taxable income. The step-up wipes that out. The heir starts fresh with a new basis and a new depreciation schedule.

One prerequisite catches people: the property must be included in the decedent’s gross estate to qualify.1Office of the Law Revision Counsel. 26 USC 1014 – Basis of Property Acquired From a Decedent If ownership was transferred out during life through a gift or irrevocable trust, the basis reset may not apply.

Your LLC’s Tax Classification Controls Everything

An LLC is a state-law entity. For federal tax purposes, the IRS ignores the LLC label and looks at how many owners it has and what elections have been filed. That classification decides whether a step-up reaches the property inside.

Not sure which one you have? Look at what the LLC files. A disregarded entity files nothing separate. A partnership files Form 1065. A C corporation files Form 1120. An S corporation files Form 1120-S.

Single-Member LLC: The Step-Up Is Automatic

Property inside a single-member LLC gets a full step-up when the owner dies, with no special filings beyond normal estate administration. Because the LLC is disregarded, the assets are treated exactly as if the owner had held them in their own name.2Internal Revenue Service. Single Member Limited Liability Companies Each asset resets to fair market value at the date of death.1Office of the Law Revision Counsel. 26 USC 1014 – Basis of Property Acquired From a Decedent The heir takes the LLC interest, and every asset inside carries the new, higher basis. This is the cleanest outcome available for inherited LLC property.

Multi-Member LLC: You Need a Section 754 Election

Multi-member LLCs taxed as partnerships are where families lose real money through inaction. When a member dies, the ownership interest itself gets a stepped-up basis under the general cost-basis rules for inherited property.5Office of the Law Revision Counsel. 26 USC 742 – Basis of Transferee Partners Interest The heir’s “outside basis” in the partnership interest steps up.

The step-up does not automatically flow through to the actual property the LLC holds. Without further action, the buildings, land, and equipment keep their old, lower basis on the partnership’s books. If the LLC later sells appreciated property, the heir pays tax on gains that economically belong to the period before they inherited anything.

How the 754 Election Fixes It

Section 754 of the Internal Revenue Code lets the partnership adjust the basis of its underlying assets to match the step-up in the deceased member’s interest.6Office of the Law Revision Counsel. 26 USC 743 – Special Rules Where Section 754 Election or Substantial Built-in Loss The adjustment applies only to the heir’s share of those assets. The other members’ shares are unaffected.

An example makes this concrete. An LLC with two equal members owns a building with a $400,000 basis and a $1,000,000 fair market value. One member dies. Without a 754 election, the heir’s share of the building’s basis stays at $200,000 (half of $400,000). With the election, that share is adjusted to $500,000 (half of $1,000,000). If the LLC then sells the building for $1,000,000, the heir’s taxable gain drops from $300,000 to zero.

The Filing Deadline

The 754 election must be filed with the partnership’s Form 1065 for the year in which the member died, by the return’s normal due date including extensions. The election is a written statement that identifies the partnership, declares that the partnership is electing to adjust basis under Sections 734(b) and 743(b), and is signed by an authorized partner.

This is where things fall apart in practice. Surviving members are grieving and dealing with estate logistics. The person who handled the LLC’s books may be the one who died. By the time anyone thinks about the election, the deadline can already be gone.

Late Election Relief

Miss the deadline and relief is possible but not guaranteed. Under Treasury Regulation Section 301.9100-3, the IRS can extend the time to file regulatory elections if the partnership shows it acted reasonably and in good faith and that granting the extension won’t prejudice the government.7Internal Revenue Service. Private Letter Ruling 202045004 That normally means requesting a private letter ruling, with IRS user fees and professional costs stacked on top. Filing on time is dramatically cheaper.

The Election Is Permanent

Once made, a 754 election applies to every future transfer of a partnership interest, not only the death that prompted it. Later sales and later deaths trigger the same basis adjustments. Revoking it requires IRS consent, which is rarely granted. Weigh the ongoing accounting cost against the immediate tax savings before making the call.

Corporate-Taxed LLC: The Step-Up Stops at the Stock

When an LLC elects to be taxed as a C corporation or S corporation, the entity becomes a separate taxpayer that owns its assets in its own right.4Internal Revenue Service. LLC Filing as a Corporation or Partnership The shareholder’s death steps up the basis of their shares, but the assets inside the corporation keep their original basis. No election exists to change that result for a C corporation.

The appreciation that built up during the deceased shareholder’s lifetime stays trapped inside the entity. When the corporation eventually sells appreciated property, it pays tax on the full gain from the property’s original basis. For a C corporation, gains are taxed once at the corporate level and again when distributed to shareholders, so the trapped-basis problem hurts twice.

S Corporations Are Slightly Better

Because S corporation income flows through to shareholders, an heir’s stepped-up stock basis can offset some of the tax impact when the corporation sells assets or distributes property. Tax advisors sometimes recommend liquidating a deceased shareholder’s S corporation shortly after death to achieve something close to a stepped-up basis on the underlying assets. Whether it works depends on the built-in gains tax and other factors specific to the entity. Get professional advice before moving any assets; the mechanics are unforgiving.

Community Property States: The Double Step-Up

Married couples in community property states get a bigger benefit. Ordinarily, when one spouse dies, only the deceased spouse’s half of jointly owned property is stepped up. For community property, the surviving spouse’s half also gets the step-up, so 100% of the property resets to fair market value at the first death.1Office of the Law Revision Counsel. 26 USC 1014 – Basis of Property Acquired From a Decedent

This applies to LLC property as well. The community property states are Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin.8Internal Revenue Service. Publication 555 – Community Property Alaska lets couples opt into community property treatment through a trust or agreement.

The difference can be enormous on long-held property. A couple that bought a commercial building for $300,000 forty years ago might see it valued at $2,000,000 when the first spouse dies. In a community property state, the survivor’s basis in the whole property becomes $2,000,000 and they can sell immediately with no capital gains tax. In a non-community-property state, only the deceased spouse’s half steps up, leaving the survivor with $1,150,000 in basis and $850,000 in potential taxable gain.

Getting the Valuation Right

The step-up is only worth what you can document. Publicly traded securities are easy; fair market value is the closing price. LLC property, especially real estate and closely held business interests, needs a professional appraisal pegged to the date of death. Residential appraisals often run a few hundred dollars. Commercial properties and unusual assets cost more, particularly when the appraiser has to perform a retrospective valuation to a specific past date.

Cutting corners here backfires. The IRS can challenge the reported fair market value, and if a lower figure sticks, the heir’s basis drops with it. A well-supported appraisal from a qualified professional is the defense. Keep the report permanently with the estate’s tax records, not just through the filing year, because the basis it establishes will matter whenever the property is eventually sold.