Property held in an LLC can receive a stepped-up basis when the owner dies, but whether it actually does depends on how the IRS classifies the LLC for tax purposes. A single-member LLC gets the step-up automatically. A multi-member LLC taxed as a partnership gets it only if someone files a Section 754 election on time. An LLC taxed as a corporation generally cannot pass the step-up through to the assets inside it at all. The wrong classification, or a missed filing, can cost heirs hundreds of thousands of dollars in capital gains tax that a correctly structured LLC would have erased.
What a Stepped-Up Basis Actually Does
Basis is an asset’s value for tax purposes, usually what the owner paid plus improvements. Capital gains tax is owed on the difference between the sale price and that basis. Buy a rental for $200,000, sell it for $500,000, and $300,000 is taxable.
A stepped-up basis resets the starting point at death. Most property an owner 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 same rental, worth $500,000 at the owner’s death, gives the heir a $500,000 basis. A sale the next month at $500,000 produces no taxable gain. A lifetime of appreciation is wiped clean for income tax purposes, and accumulated depreciation that would normally be recaptured as taxable income on sale disappears along with it.
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 For most LLC owners this is automatic because the membership interest sits in the estate. If ownership was moved out through a gift or an irrevocable trust during life, the step-up may not apply.
Why Your LLC’s Tax Classification Decides Everything
An LLC is a state-law entity, but the IRS ignores that label and classifies the LLC based on its number of owners and any elections on file. Three classifications matter here.
- A single-member LLC is a “disregarded entity” by default. The IRS treats it as if it doesn’t exist, and the owner reports everything on their personal return.2Internal Revenue Service. Single Member Limited Liability Companies
- A multi-member LLC is taxed as a partnership by default under Subchapter K.3Office of the Law Revision Counsel. 26 USC Subtitle A, Chapter 1, Subchapter K – Partners and Partnerships
- Any LLC can elect corporate treatment by filing Form 8832 (C corporation) or Form 2553 (S corporation).4Internal Revenue Service. LLC Filing as a Corporation or Partnership
If you’re not sure what your LLC is, look at what it files. A disregarded entity files no separate return. A partnership files Form 1065. A C corporation files Form 1120, and an S corporation files Form 1120-S.
Single-Member LLCs: The Step-Up Is Automatic
Property inside a single-member LLC receives a full stepped-up basis at the owner’s death without any special election. Because the LLC is disregarded, assets inside it are treated as if the owner held them personally.2Internal Revenue Service. Single Member Limited Liability Companies Each asset’s basis resets to fair market value on the date of death, exactly as it would if the LLC wrapper weren’t there.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. Prior depreciation is wiped out, so there’s no recapture waiting on a future sale. The heir starts a fresh depreciation schedule as if they’d purchased on the date of death. This is the cleanest outcome available for inherited LLC property.
Multi-Member LLCs: You Need a Section 754 Election
Multi-member LLCs taxed as partnerships are where the most money gets lost through inaction. When a member dies, their partnership interest itself does get a stepped-up basis to fair market value, giving the heir a stepped-up “outside basis” in that interest.5Office of the Law Revision Counsel. 26 USC 742 – Basis of Transferee Partners Interest
The problem: that step-up in the ownership interest does not automatically flow through to the actual property the LLC owns. Without more, the LLC’s buildings, land, and equipment keep their old basis on the partnership’s books. If the LLC later sells appreciated property, the heir gets taxed on gain that economically accrued before they inherited anything.
How a 754 Election Fixes It
An election under Section 754 of the Internal Revenue Code tells the partnership to adjust the basis of its underlying assets to reflect 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. The other members’ shares are untouched.
A simple example. 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. With a 754 election, that share is adjusted to $500,000. If the LLC sells the building for $1,000,000, the heir’s taxable gain drops from $300,000 to zero.
The Filing Deadline
The 754 election is filed with the partnership’s Form 1065 for the year in which the member died, by the return’s normal due date including extensions. It takes a written statement with the partnership’s name and address, a declaration that the partnership is electing to adjust basis under Sections 734(b) and 743(b), and the signature of an authorized partner.
In practice, this is where it goes wrong. Surviving members are grieving and dealing with estate logistics. The person who handled the LLC’s books may have been the one who died. By the time anyone focuses on the tax return, the deadline can already be behind them.
If the Deadline Passes
Relief exists but isn’t automatic. The IRS can grant extensions of time to file regulatory elections under Treasury Regulation Section 301.9100-3, which requires showing that the partnership acted reasonably and in good faith and that granting relief won’t prejudice the government.7Internal Revenue Service. Private Letter Ruling 202045004 Getting there usually means requesting a private letter ruling, with IRS user fees and professional costs 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 just the death that prompted it. When another member later sells or dies, the partnership must make basis adjustments then too. Revocation requires IRS consent and is rarely granted. Many operating agreements address the 754 election in advance, either requiring it or spelling out who pays the extra accounting costs. If yours is silent, that’s worth fixing before a death forces the question.
LLCs Taxed as Corporations: Basis Stays Trapped
When an LLC elects C corporation or S corporation treatment, the entity becomes a separate taxpayer that owns its assets in its own right.4Internal Revenue Service. LLC Filing as a Corporation or Partnership A shareholder’s death does step up the basis in their shares, but the assets inside the corporation keep their original basis. For C corporations, no election fixes this. The structure walls off the shareholder’s basis from the asset’s basis.
The appreciation that built up during the shareholder’s lifetime stays trapped. If the corporation sells an appreciated property, it pays tax on the full gain measured from the original basis. For a C corporation, that gain is taxed at the corporate level and taxed again when distributed to shareholders.
S corporations have slightly more room. Because S corporation income flows through to shareholders, the heir’s stepped-up stock basis can offset some of the tax hit when the corporation sells or distributes property. Tax advisors sometimes recommend liquidating a deceased shareholder’s S corporation shortly after death, which can approximate the economic result of a step-up on the underlying assets. The mechanics depend on whether the S corporation is subject to the built-in gains tax and should not be attempted without a tax professional.
The Community Property Bonus
Married couples in community property states get a meaningful bonus. Normally, when one spouse dies, only the deceased spouse’s half of jointly owned property receives a step-up. For community property, the tax code steps up the surviving spouse’s half too, resetting 100% of the property’s basis 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. If a married couple jointly owns a single-member LLC, or each holds a membership interest in a multi-member LLC, in a community property state, the full basis resets when the first spouse dies. 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 in through a trust or agreement.
Consider a couple that bought a commercial building for $300,000 forty years ago, now worth $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 an immediate sale produces no capital gains tax. In a non-community-property state, only the deceased spouse’s half gets the step-up, leaving the survivor with $1,150,000 in basis and $850,000 in potential taxable gain.
The Appraisal Matters
A stepped-up basis is only as good as the valuation that establishes it. For publicly traded securities, fair market value is easy. For LLC property, especially real estate, closely held business interests, or unusual assets, you need a professional appraisal as of the date of death. Residential appraisals typically run a few hundred dollars; commercial properties and complex assets cost more, particularly for a retrospective valuation tied to a specific past date.
Cutting corners on the appraisal is a false economy. The IRS can challenge the reported fair market value, and if the agency successfully argues for a lower figure, the heir’s basis drops with it. A well-documented appraisal from a qualified professional is the best defense. Keep the report permanently with the estate’s tax records.
What To Do Now
Entity choice carries real estate planning consequences beyond liability protection. A single-member LLC or a partnership-taxed multi-member LLC gives heirs the best shot at a full step-up on the underlying assets. A C corporation election is the worst outcome for basis purposes, with no mechanism to push the step-up through to the entity’s property.
For a multi-member LLC, address the 754 election in the operating agreement now. Specify whether the election will be made, who’s responsible for filing it, and how the extra accounting cost gets allocated. Have that conversation with a tax advisor while every member is alive and the question is still hypothetical, rather than after a death starts the clock on a filing deadline nobody is watching.