What Gets a Step-Up

Published on: 17:41PM Jan 26, 2016

I continue to get questions regarding how much of a step-up in cost basis farmland gets when someone passes away.  Again, as with most tax questions, it depends.  The key factor for determining the step-up is who owns the land.  Is it owned by the person who passed away or is it owned by an entity that is then owned by the person who passes away.  Let's go through a few examples.

Farmer Brown owns 500 acres of good farmland worth $5 million.  He passes away in 2016 and leaves it to his wife.  His wife's cost basis in this farmland will now be $5 million.

Farmer Brown and his wife own jointly 500 acres of ground worth $5 million.  They paid $500,000 for it 40 years ago.  Farmer Brown passes away in 2016.  His 1/2 is worth $2.5 million.  This plus his wife's basis of $250,000 (1/2 of $500,000) or $2,750,000 is now her new cost basis. 

Farmer Brown and his wife had put the land into a C corporation many years ago.  When he passes away his half of the stock in the C corporation is stepped-up to fair market value which is likely less than $2.5 million.  It is discounted for lack of marketability and minority interest.  None of the farmland value inside of the corporation gets a step-up.  If the corporation sells the farmland for $5 million, it will then owe federal and state tax on a full $4.5 million gain.

Same facts, but the corporation is an S corporation.  The result is the same.  No step-up in basis for the farmland.  Full gain when the land is sold.  However, if that is only asset inside the S corporation, then the corporation can be liquidated and likely there will be a loss on liquidation to offset the gain on the sale of the farmland.  This is true, if and only if, capital assets such as farmland are inside the corporation.

Now Farmer Brown and his spouse put the ground into a LLC.  When he passes away, the LLC can make an election to step-up the basis of the farmland to reflect the fair market value of $2.5 million (may be some slippage for discounts due to lack of marketability and minority discount).

As you can see, a C corporation is worst for ownership of farmland when you pass away if your heirs plan to sell it.  Next worst is an S corporation.  An LLC is good, however, you may have to discount it a bit for lack of marketability and minority discounts.  The best is to own the property outright (assuming you owe no estate taxes).

If you live in a community property state, then usually both halves of the asset get a step up.  The spouse who passes has a step-up for their half and the surviving spouse also gets to step up their half.  It is a good thing to live in a community property state when you pass away (at least your spouse will thank you).