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.
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.
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.
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.
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 §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.