Upon death, the decedent’s estate is required to report as tax basis for estate tax purposes the fair market values of all applicable assets—either the values at date-of-death, or at the alternate valuation date, if elected.
If the value of the individual assets includible in the estate exceeds their respective tax bases (generally their original costs plus improvements and other adjustments), then the assets will receive a step-up in their tax bases to the value on the valuation date. Alternatively, if the values of assets are less than their tax bases, such assets will receive a step-down to the lower amount.
The Surface Transportation and Veterans Health Care Choice Improvement Act of 2015 (Act) made additions to reporting requirements to curtail perceived abuses in the reporting of tax basis of assets in an estate. Before the Act, there was no requirement for the estate to notify beneficiaries of the asset values reported on the estate tax return.
Tax Issues Arising with Ownership Interests in Partnerships
The death of a partner in a general, an LP or LLC can have additional tax basis complications that are often overlooked by tax practitioners. A step-up in basis of a partnership or LLC interest upon the death of a partner/LLC member will only apply to the “outside” basis, i.e., the tax basis of the interest in the hands of the successor owners. This change to the outside basis will create a discrepancy between such outside basis and the successor owners’ share of the partnership’s basis of its assets as recorded within the partnership’s books, i.e., the “inside” basis.
For successor owners to realize the tax benefits arising from their step-up in outside basis in a timely manner, the partnership’s inside basis should have a corresponding step-up. This will allow successor owners to claim current tax deductions for additional depreciation and amortization on the stepped- up basis of the inside assets. In the event that a specific partnership asset is sold, they could reduce any recognized gain on sale by the appropriate amount of additional basis. Without this corresponding step-up to the inside basis, the successor owners would only be able to utilize their increased outside basis when they dispose of their interest or upon the ultimate liquidation of the partnership.