Husband & wife LLC at death of husband & step-up in basis

I have researched this for hours and I would think I could find a white paper or web article or blog or something that addresses this but I cannot. I can only go by reading the code and regs and research service explanation which I can't understand 100%.

How is the estate step-up in basis handled in this case?

We have a husband and wife jointly owned LLC. The LLC operates a sound/recording studio. The interests are held joint with right of survivorship and the LLC has filed Form 1065 since inception. Husband dies and the wife continues the business as SMLLC (Schedule C). The H's 50% interest is valued at 100K with approx 30K value in the equipment and 70K goodwill/going concern value. There is no 754 in effect for the LLC. The basis in the assets in nominal due to depreciation and the goodwill being self created, not purchased. The death was unexpected and as a result there has been a delay in getting all the affairs taken care of by the spouse and we are outside the window for making a 754 or 732(d) election (or the 12 month late election).

Due to there no longer being a partnership, the partnership terminates under 708. However when is the termination considered effective? Due to the ownership being JWROS and the husband's interest going direct to the wife, is there still a brief instant where the husbands estate owns the LLC interest where a 754 election may apply and where upon transfer to the wife we have a Rev Rul 99-6 scenario? Or is the wife considered directly inheriting H's 50% of the LLC assets directly with no need for a 754 election or going through the steps of RR 99-6.

If we do have a RR 99-6 scenario where each partner's share of partnership assets is considered distributed to the partners and then W inherits H's 50% of the assets, again does a 754 election at the partnership level need made? Further if 754 election is not made, and only H's partnership interest is stepped up, not the partnership assets, then does the 732 basis allocation rules apply under the RR 99-6 scenario? Also do we have a mandatory application of 732(d)? One of the requirements for 732(d) to be mandatory is Reg 1.732-1(d)(4)(ii) which says there has to be shift in basis from nondepreciable/nonamortizable assets to depreciable or amortizable assets when compared to the normal 732(c) allocations. Since the goodwill would be amortizable, does this eliminate the 732(d)?

I believe all this affects whether all of the husband's step is applied to the equipment due to the general basis allocation rules under 732 or if step up is applied to both the equipment and goodwill. Or maybe without a 754 election there is no depreciable or amortizable step-up in basis in the assets at all?

If we can get a step up in the basis of the assets under the RR 99-6 scenario, under the general basis allocation rules (732(c)), upon liquidation where outside basis exceeds the inside basis of assets, the self created goodwill, I don't believe, is allocated any basis since it not considered distributed property for 732. However, if 754 was in effect, then the goodwill would be allocated a portion of the 743(b) basis adjustment. Therefore, if 732(d) applies then we must allocate the goodwill share of the basis adjustment to goodwill.

You shouldn’t need a 754 election here because you have the outside step-up coupled with the termination.

Wife’s basis in the assets will be ½ of the inside basis (i.e. her share of inside basis) plus the $100k (i.e. inherited stepped-up basis; $70k to goodwill and $30k to equipment). Thus, we get a half step up.

I do agree that the principles of RR 99-6 should be applied to this situation. I realize the death throws a wrinkle in things. But what you should do is correlate the acquisition by wife via inheritance to the purchase in Situation #1 of the RR.

I’d do it this way:

Wife’s ½ of assets are deemed distributed to her. She’ll take a low (or no) carryover basis.
H’s assets are deemed distributed to H.
Then H dies.
So basis to estate of those assets is now $100k.
Then wife purchases those assets from the estate for $100k.

Or, you could modify the last 2 sentences to say:
Basis in those assets is now $100k.
Wife inherits those assets and takes a $100k basis.

In the RR, the step-up occurs via purchase, and step-wise, the purchase comes after the distribution.

In your case, the step-up occurs via death, and step-wise, the death comes after the distribution.

Stick with the $70k/$30k allocation and don’t rack your brain about in distribution nuances that could result in some different basis allocation with respect to H’s share of the assets. I wouldn’t go there.

Thank you Jeff. You input is always appreciated. I was really unsure in what order things happened in this particular scenario. Your analysis makes sense. When someone buys out another, under RR 99-6, it is the purchase that causes the termination of the partnership, and in the RR, for the purchaser, the distribution comes right before the purchase. So, in my case, with the death causing the termination, for the wife (purchaser) we move the distribution prior to the death. Thanks again!

Sure. No problem.

The case that RR 99-6 is based on is called McClausen. That case involved a death. The issue pertained to holding period. There was a two person partnership, one partner died. The partnership didn’t terminate. Decedent’s partnership interest went to his estate and maybe eventually to his wife, I can’t remember. The existing partner bought that partnership interest from the estate (or from the inheriting wife). Now the partnership terminated. And then, within 1-year, the existing partner sold some partnership assets. He claimed that when he purchased the interest, he shouldn’t be viewed as purchasing assets. Thus, when he sold the assets after the partnership terminated, he claimed he received all of them via partnership distribution. And going that route meant they would all be long-term, since the partnership had held them all over 1-year. IRS said, “Not so fast.” IRS argued that when he purchased the partnership interest, he effectively purchased assets, thereby establishing a new holding period on those purchased assets. Court rules in favor of IRS. So, whether right or wrong, that is the source of this rule in RR 99-6 that says the purchaser has purchased assets when a partnership terminates by way of one partner buying out the other.

But as we have noted, in order for the purchaser to have purchased assets from the seller, even though he really didn’t from a legal standpoint, the seller has to get the assets first. This means we have to construct a sequence of events to match that idea.

Good info, Jeff. Thank you for your time.