Insights

The §754 Election: Family LLC Operating Agreements

mario@summit.law (Mario Bai) — Wed, 10 Jun 2026 13:37:06 GMT

Why the step-up in basis your heirs are counting on may never reach the assets that actually matter and how proper architecture fixes it before it costs seven figures.

Ask any estate planning attorney what happens to appreciated assets at death, and you'll get the textbook answer: the heirs receive a "step-up" in basis to fair market value, and decades of built-in capital gain quietly disappears. That answer is correct, and, for families who hold their wealth inside an LLC or family partnership, dangerously incomplete.

Here is what the textbook answer misses: when a member of a Family LLC dies, the basis step-up attaches to the membership interest, not to the real estate, securities, or operating assets inside the entity. Unless the LLC makes a timely election under Section 754 of the Internal Revenue Code, the gain your family spent a generation building doesn't disappear at death. It simply goes dormant, waiting inside the entity for the day the heirs sell, at which point they pay capital gains tax on appreciation that, economically, was already extinguished.

We have reviewed many otherwise sophisticated estate plans where this single omission would have cost the family more than the entire federal estate tax exposure the plan was designed to avoid.

Two Bases, One Asset

Partnership taxation, which governs most multi-member LLCs, runs on a dual-basis system that most planning never engages with:

Outside basis is what each member has in their membership interest itself. When a member dies, Section 1014 steps this up to fair market value automatically. This is the step-up everyone knows about.

Inside basis is the LLC's own basis in the assets it holds, the buildings, the brokerage account, the operating company. Death does nothing to inside basis. By default, it stays exactly where it was, no matter how many members die holding interests in the entity.

The result is a structural mismatch: the heir's outside basis says "no gain here," while the entity's inside basis preserves every dollar of historic appreciation. The Code's bridge across that gap is the Section 754 election, which unlocks a basis adjustment under Section 743(b), stepping up the inside basis of the LLC's assets, but only with respect to the deceased member's transferred interest, and only if the election is actually in place.

What the Mismatch Costs: A Working Example

Consider a structure we see constantly in South Florida: a Family LLC holding commercial real estate worth $20 million, with a depreciated inside basis of $4 million. The founding member, call him the patriarch, owns 50%, and his outside basis in that interest is $2 million.

At his death, without a §754 election:

His daughter inherits the 50% interest with an outside basis stepped up to $10 million. On paper, the step-up worked. But two years later, the family decides to sell the building. The LLC recognizes $16 million of gain, and $8 million of it is allocated to the daughter, gain on appreciation that occurred entirely before her father's death, appreciation the estate tax system already valued and the income tax system was supposed to forgive. At combined federal rates, that's roughly $2 million of tax on phantom gain. (Her stepped-up outside basis eventually produces an offsetting loss, capital, deferred, and frequently stranded where she can't use it.)

With the election in place:

The §743(b) adjustment steps up the inside basis of the LLC's assets by $8 million, but solely for the daughter's benefit. When the building sells, her share of the gain is eliminated. And if the family doesn't sell, the result is arguably better still: her $8 million adjustment to depreciable real property generates a fresh depreciation schedule, on the order of $200,000 per year in new deductions against the property's income, recovered over the asset's remaining recovery period. The election doesn't just prevent a tax; it manufactures an ongoing income tax asset.

One checkbox. Seven figures of swing.

Why Competent Plans Miss It

If the election is this valuable, why is it so routinely absent? Because it lives in a jurisdictional gap between professions.

The election is made by the LLC, not by the estate, filed with the partnership's tax return for the year of the transfer. The estate planning attorney drafts the trust and the will; the CPA prepares the 1065 from last year's workpapers; nobody's engagement letter covers the question of whether the operating agreement even permits the election, or who has the authority to compel it. In families where the surviving members and the deceased member's heirs have diverging interests, and after a death, they often do, a manager with no contractual obligation to make the election can simply decline.

There are also legitimate reasons for caution that demand actual analysis rather than a reflexive checkbox. The election is irrevocable without IRS consent and applies to every future transfer and distribution, not just the one in front of you. It imposes real ongoing accounting complexity, because §743(b) adjustments are tracked transferee-by-transferee. And the knife cuts both ways: where assets have declined in value, the adjustment runs downward, and under §743(d), a downward adjustment is mandatory when there's a substantial built-in loss, election or no election.

This is precisely the kind of decision that should be architected in the operating agreement at formation: mandating the election (or vesting the authority clearly), allocating the accounting burden, and aligning the manager's duties with the family's basis strategy, not improvised by a grieving family against a tax-return filing deadline.

The Discount Trap: Where Old Planning Collides With New Law

There is a second-order issue here that separates genuine tax architecture from form-driven planning. The §743(b) step-up is measured by the outside basis of the transferred interest — which means every valuation discount applied to that interest at death directly shrinks the inside basis adjustment available to the heirs.

For twenty years, the standard playbook was to layer lack-of-control and lack-of-marketability discounts onto family entity interests to compress estate values. That made sense when the estate tax was the predator. But as of January 1, 2026, the federal exemption stands at a permanent $15 million per person, now $30 million for a married couple, and with no sunset. For the substantial majority of families holding wealth in entity structures, the federal estate tax is no longer the binding constraint. Income tax is. A 35% discount that saves zero estate tax for an exempt estate, while permanently forfeiting millions in basis step-up, is not conservative planning. It is an unforced error executed with great formality.

The modern analysis asks a different question entity by entity, asset by asset: where is this family's real tax exposure, and is the structure engineered to maximize basis where the estate tax no longer bites, all while preserving compression where it still does?

The Architecture View

The §754 election is not exotic. It is black-letter partnership tax. What is rare is the discipline to integrate it, importantly, at the drafting stage, with the valuation strategy, the trust design, the depreciation profile of the underlying assets, and the family's actual exposure under the post-2026 exemption regime. That integration is the difference between owning a set of estate planning documents and owning a tax architecture.

If your family's wealth sits inside an LLC or partnership and you cannot say, today, whether a §754 election is in place, who controls it, and what it would be worth at the next transfer, that is a conversation worth having before the next transfer happens.

Summit Law advises ultra-high-net-worth individuals, family offices, and founders on tax, trust, and structural planning across Florida, New York, and New Jersey. This article is for general information only and does not constitute legal or tax advice; the application of §754 and §743(b) depends on facts specific to each entity and transfer.

GRATs at scale: when the math actually works for founders.

mario@summit.law (Mario Bai) — Wed, 10 Jun 2026 12:56:49 GMT

A tax advisory perspective on Grantor Retained Annuity Trusts for founders and operators: when the §7520 hurdle, asset volatility, and rolling structure actually move generational wealth, and when a GRAT is the wrong vehicle.

Grantor Retained Annuity Trusts are the most discussed and least well-implemented estate technique we see in tax advisory practice. Almost every founder we work with has heard the term. Almost none of them have a GRAT positioned to actually do the work it is capable of. The gap between "we set up a GRAT" and "the GRAT moved $40M of pre-liquidity appreciation outside the estate" is enormous, and it is almost entirely a function of how the planning is modeled, by the founder's tax advisors and estate counsel together, before the trust is funded.

The mechanics in 60 seconds

A GRAT is a grantor trust funded with an asset the grantor expects to appreciate. The grantor receives back a fixed annuity stream over a specified term, calculated to return the original principal plus a statutory hurdle rate (the §7520 rate, published monthly by the IRS). Anything the asset produces above that hurdle remains in the trust at term, outside the estate, transferred without using lifetime exemption, and often payable to a continuation trust for descendants.

When the planning is sound, the gift-tax cost of funding the GRAT can be modeled to near zero. The downside, when the asset underperforms the hurdle, is also near zero. The assets simply return to the grantor and no exemption has been consumed. This asymmetry is the entire point of the technique.

The two questions every founder asks

1. "Why not just gift the shares?"

Because outright gifts permanently consume lifetime gift-and-estate exemption. Under the One Big Beautiful Bill Act, the federal estate and gift tax exemption is $15 million per individual beginning in 2026 ($30 million for married couples using portability), indexed for inflation starting in 2027, with no scheduled sunset. That is meaningfully higher and more stable than the prior framework, but it is still a finite amount, and 40% federal estate tax still applies above it. A GRAT can move appreciation off the estate balance sheet without using meaningful exemption, which preserves that exemption for the founder's other purposes. Said differently, the exemption is no longer a "use it or lose it" resource on a clock, but it is still a scarce resource worth conserving for assets where it does the most work.

2. "What if the asset goes down?"

The grantor receives the assets back through the annuity stream, no gift tax has been triggered, and no exemption has been consumed. The founder is then free to work with counsel to fund a new GRAT at a lower asset value and possibly a lower hurdle rate. This is the reason rolling short-term GRATs typically outperform a single long-dated GRAT on volatile assets, a point we will return to.

Why short-term rolling GRATs tend to beat long-dated ones

A 10-year GRAT funded with a single block of pre-IPO shares is a single coin flip. If the company underperforms the hurdle in years 1 through 4 and recovers in years 7 through 10, the GRAT can still largely fail, because the annuity payments early on strip the upside back out. A series of rolling 2-year GRATs, by contrast, captures each up-cycle independently and absorbs the down-cycles without permanent damage.

Down year: assets return to the grantor; the founder and counsel can consider funding a new GRAT at the new lower value.
Flat year: hurdle is met, modest excess transfers, trust continues.
Up year: hurdle is materially beaten, larger excess transfers, founder considers funding the next layer.

Across a full liquidity cycle, the rolling approach tends to compound the wins and absorb the losses. A single long GRAT averages them together, which is generally the wrong behavior on a high-volatility asset. The right cadence for any particular founder is a planning decision made with the estate attorney.

The hurdle rate, and why timing matters more than size

The §7520 rate determines the annuity stream the GRAT must return. Funding a GRAT in a low-rate environment means a lower bar for the asset to clear. Funding the same GRAT a year later, after a meaningful move in the rate, can change the projected transferred wealth at term substantially on identical asset performance. The rate is published monthly. We monitor it closely as part of the modeling work we do for clients.

A note on the §7520 rate

The hurdle rate for a GRAT is locked at funding. A high-rate environment is not, by itself, a reason to set the technique aside. It is a reason to consider funding with an asset whose expected return is projected to clear the rate by a meaningful margin. The relevant comparison is not rate versus zero. It is rate versus asset CAGR.

Pre-IPO vs post-IPO funding

Pre-IPO is the obvious window: illiquid shares, low 409A valuation, expected re-rating to the public market, with the GRAT positioned to capture appreciation above the hurdle. Valuation considerations on the funded shares (lack of marketability, minority interest), determined by qualified independent appraisers, can further compress the gift-tax footprint, subject to counsel's review.

Post-IPO is harder but not closed. After lockup, a founder with a view on continued appreciation can work with counsel to fund GRATs with public shares and capture upside above the hurdle. Marketability discounts are no longer available, but liquidity makes the annuity payments mechanical and reduces administrative friction. Post-IPO GRATs coordinated with a 10b5-1 plan are a common scenario, with the trading plan handled by securities counsel and the trust work by estate counsel.

What commonly undermines a GRAT

Weak valuation work. A GRAT is only as defensible as the appraisal underneath it. Valuations done by a generalist appraiser unfamiliar with the asset class create audit exposure that compounds for the life of the trust. We help clients identify qualified appraisers; the engagement and reliance is the client's, with counsel's input.
Grantor death during the term. If the grantor dies inside the GRAT term, assets are generally pulled back into the estate. Term length is therefore a mortality consideration as much as a return consideration, one we model, and one the attorney weighs in setting the trust terms. Shorter terms are often discussed for older grantors; longer or rolling terms for younger founders.
Liquidity for the annuity payments. The trust must have either cash or distributable assets to make the annuity stream. For illiquid pre-IPO funding, in-kind distributions back to the grantor are common, and the mechanism must be drafted into the trust by counsel from the start.
Lead time. For founders approaching a capital event, the productive window for GRAT modeling is roughly 18 to 24 months ahead of the event. The unproductive window is the day the term sheet arrives. By then, valuation positioning is largely fixed, §7520 timing is locked in, and the set of available moves is much narrower.

The bottom line

Used correctly, GRATs do not save current-year tax. They are designed to move the future appreciation of an asset outside the estate, with limited downside if the bet does not pay off. There are very few techniques with that asymmetry. Founders who pursue them seriously, early, and in series, with engaged tax advisors and estate counsel working in tandem, can transfer eight and nine figure sums of future appreciation to the next generation while preserving the bulk of their lifetime exemption for other uses.