Our real estate partnership's owner died before the building sale. Does the heir get a basis step-up?
The successor may receive a new basis in the inherited partnership interest, but the partnership's building basis does not automatically rise on a partner's death. A valid Section 754 election—or a mandatory adjustment in a substantial-built-in-loss case—can require a Section 743(b) adjustment for the successor alone. If the partnership sells soon after the death, its common gain and the successor's partner-specific adjustment must be reported together. The estate's interest valuation, debt share, income in respect of a decedent, election status, and sale timing all affect the calculation. The IRS partnership publication expressly separates an inherited partner's interest basis from the partnership's asset basis.
This is a pre-filing task for the executor and the managing partner—not a general promise that a sale-year K-1 will be tax-free. Obtain the date-of-death valuation and the partnership's return workpapers before the estate, partnership, or beneficiaries sign their returns.
First identify what was inherited
The decedent owned a partnership interest; the partnership owned the building. Under the inheritance basis rules, the estate or other successor generally determines a new outside basis in the interest. The partnership still carries its existing inside basis in the building for the other owners. The inherited-interest basis needs the actual estate valuation, the successor's share of partnership liabilities, and any items that are income in respect of a decedent (IRD); it is not necessarily the amount in the K-1 capital-account box. See Publication 541's basis and liability discussion and the IRS partner K-1 instructions.
A Section 743(b) adjustment bridges the successor's outside basis and share of partnership inside basis only when its legal conditions are met. It is personal to that successor; it does not raise the other partners' building basis or change the amount the partnership realized on a sale. The Form 1065 instructions require the partnership to identify the transferee, compute the adjustment, and allocate it to specific properties. Section 755 allocation can put part of an adjustment on land, buildings, or other assets; an appraised interest value cannot simply be entered as new building depreciation.
A simplified death-then-sale example
Assume a debt-free, four-owner partnership owns only one building with $1 million adjusted tax basis and $3.6 million fair market value. One equal owner dies. For illustration only, the estate's inherited 25% interest has $900,000 outside basis, there are no IRD items, no special allocations or valuation discounts, and the partnership has a valid Section 754 election for the death year. The estate's share of common inside basis is $250,000, so a simplified positive Section 743(b) adjustment is $650,000. If the partnership sells the building for $3.6 million soon afterward, it recognizes $2.6 million common gain; an assumed 25% share is $650,000 before considering the estate-specific Section 743(b) adjustment. A properly allocated adjustment may offset that pre-death appreciation for the estate, while the other owners do not receive the estate's adjustment. This is an illustration of basis mechanics, not a calculation of tax due or a guarantee of zero gain on an actual sale.
Now change one fact: if no Section 754 election is effective and no mandatory substantial-built-in-loss rule applies, the estate can still have outside basis in the inherited interest, but the partnership normally cannot invent the $650,000 inside adjustment. A later distribution or liquidation may have its own basis or gain consequences; it does not retroactively fix a sale-year K-1. The IRS Section 743 discussion confirms that death is a transfer event but an inside adjustment requires an election or the specified mandatory-loss condition.
Choose the filing path before the sale return is final
- Map legal ownership and dates. Obtain the partnership agreement, death certificate, estate or trust documents, transfer ledger, sale contract, and closing statement. Confirm whether the decedent, estate, trust, or beneficiaries held the interest on each relevant date. Death-year income allocations and K-1 recipients are a separate Section 706 question; the Form 1065 instructions direct preparers to account for changing interests during the year.
- Reconcile both basis systems. Get the date-of-death interest valuation, decedent and successor outside-basis schedules, liability allocations, the partnership's asset tax bases and values, and any prior Section 743(b) layers. Identify IRD, contributed-property Section 704(c) layers, and hot assets before using a one-number step-up. Treasury's basis-allocation regulations explain why the death adjustment is not assigned to IRD assets.
- Check the election and deadline. Confirm whether a Section 754 election was already in effect. If not, the partnership—not the heir alone—generally attaches an election statement to its timely filed Form 1065, including extensions, for the transfer year. It persists for later qualifying transfers and distributions unless revoked with IRS permission. If the return was filed without it, the IRS Section 754 FAQ describes an automatic 12-month late-election extension under Treasury Regulation Section 301.9100-2 and a discretionary route beyond that; do not backdate an election without satisfying the applicable relief procedure.
- Reconcile the sale and K-1 package. Allocate a valid Section 743(b) adjustment under Section 755, compute any estate-specific depreciation and gain effect, and match the Form 1065 attachment and successor K-1 statements to the estate return. If the decedent is still receiving K-1s for a later year, the IRS partner instructions tell the executor to notify the partnership and request correction. A filed return may require a different correction route depending on the partnership's audit regime.
Records and failure points to review
- Estate valuation support for the interest, not just the real estate; building and land appraisals; date-of-death and closing statements; debt schedules and guarantees.
- Prior Forms 1065, Section 754 election statement or proof of late relief, asset-level Section 755 workpapers, Section 743(b) schedules, and all death-year and sale-year K-1s.
- Estate or trust returns, beneficiary and taxpayer-identification records, partnership agreement, ownership transfer documents, prior depreciation, Section 704(c) and IRD schedules.
The common errors are treating the inherited partnership interest as if the estate directly inherited the building, entering a date-of-death value as shared depreciation for all partners, omitting a successor-specific K-1 adjustment, ignoring debt in outside basis, or promising that Section 754 always produces a positive adjustment. A transfer can also trigger a mandatory downward adjustment under the substantial-built-in-loss rules, even without an election. An election may burden future transfers, so the managing partner should evaluate the partnership-wide consequences, not just the estate's immediate sale.
This is a federal framework, not an opinion on an estate's tax bill. Estate valuation elections, IRD, liabilities, prior contributed-property gain, passive-loss limits, state law, ownership through a trust, and transaction sequencing can change the answer. AE can reconcile the estate valuation, partnership basis schedules, election status, and sale-year Forms 1065/K-1 with estate counsel before returns are signed. For the broader election mechanics, see AE's Section 754 basis guide; for a late filing, see the late-election decision guide.