Inside/Outside Basis

[Snaggletooth]

Stop me when I'm wrong.

For the last 60 years, three brothers have operated a partnership which rented a commercial building to the US Post Office. The partnership has existed 60 years as well, and the building has long since become fully depreciated with an original basis of $22,000.

The last of the three brothers died this past year. Partnership is now fractured, with 9 different heirs now holding various shares of the partnership. Appraised value of building is now $280,000.

7 of the 9 heirs are my clients. The partners want to begin depreciating the stepped up value. I say no. The partnership has been a continuous uninterrupted entity, never having lost as much as 50% of its ownership to death. As a reporting entity, the partnership keeps its fully-depreciated $22,000 on its books.

The "stepped-up basis" is the value of the partnership to its owners. The new appraised value, $280,000 can be valued and split 9 ways, and the partners can use THIS as their basis in the partnership. The partnership itself cannot use the stepped up basis. Furthermore, if the partnership sells the property, it has to use its original basis for the calculation of capital gains/4797 and then distribute the gains to the partners.

At that point, the only way the partners can take advantage of the stepped-up basis is to liquidate the partnership to the 9 owners. At that point, the partners can use their higher basis to apply against the gains.

Messy.

1) Is my above-thinking correct?
2) Are there better alternatives to realize the benefits of stepped-up basis? (For example, can the partnership be novated)

[veritas]

Partnerships

Nothing is easy.

I would look at a 754 election. This would give the heirs a stepped up inside. There is information on page 20-11 in the TTB.

But I am using an iPad which is not compatible with the online version so I can't read it.

[Roland Slugg]

Dear Snag

The partnership should make an election under Code §754 to adjust the basis of partnership property to reflect the beneficiaries' combined new stepped-up basis. (See Code §754 and related Regs.)

The increased basis should be allocated on the partnership's books to the various partnership assets in separate or sub accounts that identify the additional basis as "belonging" to the nine new partners in proportion to each of their respective interests in the partnership. Any such additional basis that's allocated to depreciable property, such as the building, should then be depreciated (or amortized as the case may be) as if it were newly acquired property. That depreciation, in turn, should then be allocated to the new partners, again in proportion to their respective interests. Everything needs to be tracked on a partner-by-partner system.

For example using the facts in your own post -- Three original partners, A, B and C ... C dies leaving his interest to nine benes, D-E-F-G-H-I-J-K-L. You would want the books to then reflect the following accounts or sub accounts: Building - Original cost, Building - Add'l Basis, Partner D, Building - Add'l Basis, Partner E ... Building - Add'l Basis, Partner L. Do the same for depreciation, land and any other assets to which additional basis is allocated.

When preparing the partnership returns and related K-1s, all the additional new depreciation is allocated to the nine new partners pro-rata to their respective interests. None of the new, additional depreciation is allocated to the original, continuing partners. Same thing for amortization and other items, if any.

Since the building in your case is fully depreciated, the situation is fairly easy. The deceased partner's basis in everything is removed and replaced by the bases of the nine new partners. If there are assets that are just partially depreciated or amortized, they are still reallocated to and become part of the FMV basis of the new partners, but the old undepreciated basis continues to be depreciated as before. Thus, in that situation you can have individual assets with split bases, two different useful lives, even two depreciation methods. That can quickly become a nightmare of minutiae. You are lucky!

[Snaggletooth]

Section §754

Thanks to Mr. Slugg and Veritas for bringing up Section §754. I had heard of this for years but never had occasion to use it. Unfortunately, most of my partnerships don't last very long, and contain only two parties who eventually don't get along and split up.

The additional suggestion to carry the revalued assets in subsidiary fashion (in proportion to each partners' interest) is also an excellent one. Allows a direct allocation of depreciation without having to recalculate. Thanks Roland.

Doesn't appear to be a "downside" to using §754 in this situation.

Another example of how helpful this board can be. I've seen §754 in the Tax Book for years and have not had occasion to use it.

[Gretel]

Same here. I agreed with your assessment, Snag. Just like you I heard of Sec. 754 several times but it did not come to mind reading your post. I am also very thankful for this board.