Here is a brief synopsis: In 2014, my spouse inherited 1/8 share of a 27 year old rental real estate business. Prior to 2014, the LLC had used ~$1M of depreciation.LLC's accountant did not file a 754 election to step-up the basis for the heirs.In 2021, the LLC paid a licensed commercial real estate appraiser to estimate the FMV at the time of inheritance. Valuation was $1.5M, using sales comparison and income capitalization approaches.The appraisal has verbiage to justify a step-up in basis to the IRS.The business and all property was sold in 2022, proceeds distributed, and the LLC was dissolved.All proceeds appear on the K-1, there is no other document from the accountant.Partner's basis can be stepped up by subtracting 1/8 share of the appraiser's FMV from the Section 1231 gain.What's odd to me is that Box 9c on my spouse's final K-1 shows unrecaptured Section 1250 gains = 1/8 of ALL depreciation that was ever taken by the LLC, going back to 1987.90% of the LLC's historical depreciation was taken prior to inheritance.My question is: are heirs responsible for ALL unrecaptured section 1250 gains over the life of a partnership?In my mind, the heir should only be responsible for their share of the LLC's depreciation taken AFTER the inheritance.And if I am correct, how to show this adjustment in TT?Thanks in advance for your advice!

LLC's accountant did not file a 754 election to step-up the basis for the heirs.Yeah, not good....see if anyone else here has a solution.

TurboTax

File with experts
File your taxes
Experts at your fingertips

An expert helps with your taxes, or does them for you
TurboTax Expert Full Service

TurboTax Expert Assist

TurboTax Self-Employed
Prior year taxes
File myself
File myself
Do it yourself

We'll guide you step-by-step
TurboTax Do It Yourself

TurboTax Self-Employed

TurboTax Desktop
TurboTax Free

Activate your product

Prior year taxes
Business
Business
Business taxes

Get your T2 corporate return done right, your way
TurboTax Business

TurboTax Business Desktop
Tax situations
Tax situations
Tax situations

Find extra guidance for your big life moves
For investors

For 25 and younger

For self-employed

For new to Canada

For life changes
Resources
Resources
Resources

Explore tax tools, get tips, and read reviews
Personal income tax calculator

RRSP savings calculator

Learning hub

TurboTax support (FAQ)

TurboTax community
Pricing

Community

TerboTacksGH

Question

Unrecaptured depreciation in Final K-1 from inherited LLC share

Forum|Forum|2 years ago
July 7, 2023
2 replies
0 views

Here is a brief synopsis:

In 2014, my spouse inherited 1/8 share of a 27 year old rental real estate business.
- Prior to 2014, the LLC had used ~$1M of depreciation.
- LLC's accountant did not file a 754 election to step-up the basis for the heirs.
In 2021, the LLC paid a licensed commercial real estate appraiser to estimate the FMV at the time of inheritance.
- Valuation was $1.5M, using sales comparison and income capitalization approaches.
- The appraisal has verbiage to justify a step-up in basis to the IRS.
The business and all property was sold in 2022, proceeds distributed, and the LLC was dissolved.
- All proceeds appear on the K-1, there is no other document from the accountant.
- Partner's basis can be stepped up by subtracting 1/8 share of the appraiser's FMV from the Section 1231 gain.
What's odd to me is that Box 9c on my spouse's final K-1 shows unrecaptured Section 1250 gains = 1/8 of ALL depreciation that was ever taken by the LLC, going back to 1987.
- 90% of the LLC's historical depreciation was taken prior to inheritance.

My question is: are heirs responsible for ALL unrecaptured section 1250 gains over the life of a partnership?

In my mind, the heir should only be responsible for their share of the LLC's depreciation taken AFTER the inheritance.
And if I am correct, how to show this adjustment in TT?

Thanks in advance for your advice!

M-MTax

LLC's accountant did not file a 754 election to step-up the basis for the heirs.

Yeah, not good....see if anyone else here has a solution.

TerboTacksGHAuthor

@M-MTax -- are you implying that a timely 754 filing would have reset the depreciation for the partnership?

Mike9241

without the 754 election there is inside and outside tax basis that are different. all the years since death didn't the heirs report the income/loss based on the k-1 without the benefit of any step up. This is continued to do this in the final year.

however, don't think you'll be over reporting income because of no Section 754 election. what can't be done because of the lack of the election is to change the k-1 numbers unless you like corresponding with the IRS and a tax bill to boot.

you have outside basis. it is unclear whether that's $1.5 million or 1/8 of that.

anyway, you start with your outside basis on the date of death add partnership income or subtract partnership loss for all the intervening years per the k-1 subtract distributions for those intervening years except 2022.

you now have a tax basis which should be higher than the cash distributions during 2022. report the disposition of the partnership interest using the 2022 distributions as the selling price and the calculated tax basis which should produce a capital loss to offset the pre inheritance depreciation.

an over simplified example descendant's and heirs allocable shars

original cost $2.75 million.

deprecation taken through date of death $2 million.

leaving inside basis of $.75 million.

property sold for $1.5 million on date of death.

inside1250 gain $.75 million (k-1) treated as capital gain.

outside basis $1.5 million = FMV DOD.

k-1 gain $.75 million.

outside basis now $2.25 million.

distribution $1.5 million (sales price of interest)

outside capital loss $.75 million.

the outside capital loss offsets the inside capital gain.

TerboTacksGHAuthor

@Mike9241 -- thanks for the info. The outside vs inside basis twists my brain into knots. To make sure that I understand what you're saying, I'll try your approach using data from the 1/8 partner share:

start with your outside basis on the date of death (per appraisal)	195
add partnership income for all the intervening years per the k-1	535
subtract partnership loss for all the intervening years per the k-1	n/a
subtract distributions for those intervening years except 2022.	(130)
you now have a tax basis which should be higher than the cash distributions during 2022	600

report the disposition of the partnership interest using the 2022 distributions as the selling price (2022 K-1 box 19A)	410
less the calculated tax basis	(600)
which should produce a capital loss to offset the pre inheritance depreciation	(190)

and FWIW:
total depreciation shown on 2022 K-1 box 9c	115
post inheritance depreciation (from actual 1065s)	10
pre inheritance depreciation (subtracting post- from total)	105

Mike9241

i may have misled you on your situation by assuming that the 1.5 million was the valuation of the decedent's interest rather than the value of the real property (ie it does not include the value of other assets like cash net of liabilities such as a mortgage). if it was the decedent's interest than what I provided was correct as to outside basis but if it was the value of just the property then the starting amount is the decedent's capital account on the date of death plus the difference between the decedent's share of the appraised value of the property and the tax basis of the decedent's interest in the property IE what would have been the IRC sec 754 step-up.

example:

decedent's share of appraised value of property $1,500.

tax basis of the decedent's share of property $300

difference $1200 (this would have been the 754 step-up had the election been made)

capital account on date of death (this would reflect any income for the part of the year before death) say $16 consisting of property of $300 less mortgage of $284

thus, in this example, the starting outside basis because 754 was not elected would be $1216.

************

if 754 had been elected and the building had been immediately sold for $1500 the k-1 would reflect no gain or any amount on line 10 or 9c after paying of the mortgage of $284 there would be $1216 left to distribute which equals the capital account

***********

now say the property was sold at year end for the $1500. depreciation taken post death and the loss for the remainder of the year was $20 (including the depreciation). line 2 would reflect a loss of $20 (depreciation) while line 9c and 10 would reflect a profit of $20 (selling price of $1500 less tax basis of $1480). mortgage payoff as above.

tax basis to start $1216 less line 2 loss of $20 plus line 10 income of $20 (line 9c is included in line 10) = $1216. notice that the pre death depreciation is gone. I cannot tell you why the election was not made.

then line

this thread may help clarify what the election would have done

https://www.bbdcpa.com/investment-company-notebook/section-754-election

the difference is that with depreciable property prior depreciation would be eliminated but the post death depreciation would be higher and the net income because of the higher depreciation would be lower.

what i gave was an example. you results differ but the 190 loss is mathematically correct. you report the numbers on the k-1 for tax purposes. the 190 loss offsets the 1250 gain on 9c of 115

and did part II schedule L of the k-1 show zero as ending capital?

it would seem that the difference between the FMV and tax basis on date of death was $190

that's because if you start with a $5 capital a/c on date of death

add the $535 income post date of death the total is $540

distributions post date of death of $130 excluding 2022 reduces basis to $410

which equals the final distribution of $410

which zero's out capital account which is what's supposed to happen.

this assumes the descendant was a partner/member from day 1 of the entity.

if the $190 is far off you may need a tax pro to review the k-1's starting with the year of death.

the 1231 gain reported on line 10 includes the 1250 recapture reported on line 9c

put another way line 10 on the k-1 shows up on line 11 of schedule D while 9c on the k-1 shows up on line 19 of schedule D.