I have written in the past how either limited liabilities company (“LLC”) or limited partnership (“LP”) interests do not qualify for the parent child exclusion of $1million assessed value of non-residential real property. If you want to utilize the parent-child exclusion, the real property must be distributed out of the LLC or LP in order for the parent to transfer the real property to his or her children.
Now there is another reason to consider distributing the real property today to a member or partner in order to avoid the loss of a step-up in basis upon death. This loss applies to LLC and LP interest holders only.
The Internal Revenue Service (“IRS”) on August 3, 2018 issued new proposed regulations (“Regulations”) that may cause additional planning of both LLC and LP interest regarding the 20% deduction of Qualified Business Income (“QBI”) on rental property income. There are two main issues that will impact your tax deduction. One is the threshold amount of your taxable income (single person with taxable income more than $157,000 and married couple 315,000). The other is whether or not you purchased the real property within the last 10 years, and also the 2.5% cost on all qualified property tests (building) for depreciation.
If property is inherited and immediately placed in service by the heir, the basis in the property will generally be its fair market value at the time of the decedent’s death, but the Regulations do not mention whether this resets the property’s depreciation period for the purposes of Section 199A. This applies even if there is personal or other use of the property, not directly related to the applicable trade or business.
Property owned by a partnership will not receive a step-up in basis upon the death of a partner, as the Regulations state that basis adjustments under Sections 734(b) and 743(b) (when a 754 election is in effect for the partnership) will not be taken into account in determining the entity’s unadjusted basis Qualified Property. The Regulations now are similar to the loss of the parent-child exclusion of $1 million assessed value on either an LLC or LP interest.
It appears that if an LLC or LP owning appreciated property is distributed prior to the death of a partner or the sale of a partnership interest, then the property may benefit from a full basis step-up upon the partner’s death or the sale of the partnership interest, which would not occur if the property were still held in the partnership, even if a 754 election was in place. Because many taxpayers will not benefit from discounts these entities afford for estate tax purposes while exemptions are high, it may be advantageous to liquidate entities before a partner’s death or before the sale of a partnership interest in some instances.
There are many ways to plan for avoiding either the loss of the parent child exclusion of $1 million assessed value and now the lack of step-up in basis on a spouse or parent’s death. For the parent-child exclusion, the title has to be in the parent’s name. Where the parent-child exclusion is not important, a tenant in common arrangement with single member LLC as the owner of the property will be a typical planning arrangement.