LLCs and possibly losing step up basis

[Becca F.]

I know this is the millionth post about LLCs. I've talked to two investors in California and they said if a property is in an LLC, your heirs (my kids) would lose the step up basis. For example: if I bought a house in California for $500,000 and at the time of my death it's worth $1.5 million. Kids decide they don't want to continue renting it out and sell it and current market value is $3 million. I could also use lesser amounts on my Midwest properties, same concept, purchase price $120,000 and it's worth $300,000 at the time of my death. Kids want to sell it in the future and it's worth $500,000.

The step up basis is they subtract the sale price of $3 million and $1.5 million so proceeds are $1.5 million and they pay capital gains tax on that amount. My layperson knowledge of this is if they lose the step up basis it's $3 million minus my original purchase price of $500,000 so now they pay capital gains tax on $2.5 million. 

If I had my properties in a Wyoming LLC for anonymity and the property can't be traced back to me as the parent, aren't my kids inheriting this property through a business, the LLC (losing the parent-child transfer)?

[Ashish Acharya]

That is not correct.

[Becca F.]

Quote from @Ashish Acharya:

That is not correct.

What part is incorrect? That's what two investors in California told me. I haven't talked to an attorney about the LLC issue and how my kids would inherit my properties yet. I'm looking for an attorney who's knowledgeable about how to structure these entities without tax implications for my heirs.

[Bjorn Ahlblad]

Talk to your CPA about 'gifting' the properties and any other wealth to your heirs before you die. Get rid of the 'inheritance' part. You have a limit of just over 11 million and married couple just over 22 million. 

[Henry Clark]

Not financial advice.  Talk with your cpa and lawyer.  

C corporations you own stock and no stepped up basis.

LLC doesn't matter what state since this a federal irs designation has no impact on stepped up basis. If there is a co owner their portion does not get stepped up at your death. Problem is valuation. Which you should have built into your operating agreement a methodology.

There are other methods to address death taxes.

  As mentioned annual gifting.  You can set this up so they have no control.  

You could use term life insurance to offset taxes.  

You could see to them with seller financing if you wanted to transfer before your death.  Again talk with your tax and legal person so this is regarded as arms length buts at a wry low price and interest only rate.

[Jerry W.]

@Becca F., you REALLY need to talk to a CPA about this, not an attorney unless they do tax law.  I am not an expert, but if a property has appreciated $2.5 Million, I WOULD NOT gift it to my children.  If an attorney recommended to them to do that I would file a grievance against him for incompetence.

When you gift a property during your lifetime the basis of the gift to your children is what you paid for it. If you die and they inherit it from your estate, a trust, or most forms of an LLC they get a free stepped up basis. Free stepped up basis is entirely different from inheritance tax, which is set at over $11 Million currently, but is likely to drop to $5 Million is 2025 with a 40% tax for amounts over that amount. The rationale behind the free stepped up basis is that it is not fair to pay a 40% tax on capital gains and a 40% inheritance tax. The Biden administration had tried to do away with the free stepped up basis but it gained no traction. We lost a lot of family farms and businesses in the 1970s and 80s because of inheritance taxes starting at $125K and being at 30% and going up to 70%. The outcry from that led to many of the changes we are enjoying today.

TALK TO YOUR CPA.  Do not put long term holds into Sub S elected LLCs or corporations.  Those do NOT get the stepped up basis.  Actually corporations do not get a free stepped up basis, only the stock would if you sold the stock.

[Becca F.]

Quote from @Jerry W.:

@Becca F., you REALLY need to talk to a CPA about this, not an attorney unless they do tax law.  I am not an expert, but if a property has appreciated $2.5 Million, I WOULD NOT gift it to my children.  If an attorney recommended to them to do that I would file a grievance against him for incompetence.

When you gift a property during your lifetime the basis of the gift to your children is what you paid for it. If you die and they inherit it from your estate, a trust, or most forms of an LLC they get a free stepped up basis. Free stepped up basis is entirely different from inheritance tax, which is set at over $11 Million currently, but is likely to drop to $5 Million is 2025 with a 40% tax for amounts over that amount. The rationale behind the free stepped up basis is that it is not fair to pay a 40% tax on capital gains and a 40% inheritance tax. The Biden administration had tried to do away with the free stepped up basis but it gained no traction. We lost a lot of family farms and businesses in the 1970s and 80s because of inheritance taxes starting at $125K and being at 30% and going up to 70%. The outcry from that led to many of the changes we are enjoying today.

TALK TO YOUR CPA.  Do not put long term holds into Sub S elected LLCs or corporations.  Those do NOT get the stepped up basis.  Actually corporations do not get a free stepped up basis, only the stock would if you sold the stock.

 Thank you. I do my own taxes and am looking for a local CPA (have no recommendations from friends yet). I hold all properties in a Revocable Trust in my name. All my assets are to be divided up equally between my children. I've left specific instructions to not sell the properties and do something dumb and buy a Ferrari or blow it on expensive vacations (but I guess if I'm dead and they do that, they'll suffer the financial consequences later).  If they continue to rent out my properties that's a really nice income for them. My Midwest properties have low mortgage payments and balances (relative to California) they could almost pay the loans off if they wanted to. If I were to have the properties under LLCs, I would do it as a sole proprietorship. My understanding is that it's a pass through entity and I would file the LLCs under my personal income tax returns. No S corps. What's a Sub S? 

I'm highly unlikely to gift my properties to my children. This is what parents in California were doing last 3 years, gifting homes to adult children, because of Proposition 19 effective February 2021. Adult children who inherit properties inherit their parents' low property tax basis (primary home or investment property) because of Prop. 13, passed in 1978. This is one of the great things about California since we get taxed in so many other ways. Some people are paying $2000 property tax while their neighbor next door who bought in 2018 is paying over $20,000 property tax on comparable houses with market value of $1.6 million. With Prop 19, the child has to live in it as a primary residence to get the lower property tax basis. If it's an investment property it's reassessed at market value for property taxes. All these parents gave their adult kids their homes, some while the parents are still living in the primary residence. This is a separate issue from the step up basis but would seem to have significant financial implications for both parents and children. 

[Jerry W.]

@Becca F., the Sub S is an election you can file with the IRS to give pass through status to a corporation or even an LLC. It allows you to claim part of income as passive and part as wages. It is usually only used for things like flips that generate a lot of active taxable income. Do not do it for regular rentals.

[Gina Tse-Louie]

Used to be tax benefits to LLCs...  finding out California will dig down to Members benefitting from around he world.