Your Family Business Can Outlive You: How a Trust Passes Partnership Interests to Heirs With a Stepped-Up Basis

He started the business decades ago with one truck and a handshake. Today he and his wife own most of it through a family partnership, and two of their children run the warehouse and the routes. He is past 70, and his plan is simple: when he dies, the kids open the doors on Monday morning as usual.

On paper, the plan is harder. His partnership interest is now worth many times what he put in. If it passes the wrong way, the children inherit his old, low basis and owe capital gains tax on his lifetime of growth when they sell. If it goes through probate, a court stands between the business and its next payroll.

Plenty of families are in the same spot. Estate tax returns filed in 2024 reported real estate partnerships on 2,056 returns and other limited partnerships on 1,899 returns. The top 1% of households hold 53% of all private unincorporated business assets.

A Step-Up Erases a Lifetime of Built-In Gain

Basis is the starting point the IRS uses to measure gain. Under 26 U.S.C. § 1014(a), property acquired from a decedent gets a new basis. IRS guidance says that basis is generally the fair market value on the date of death. The executor may instead choose the alternate valuation date. An inherited capital asset also counts as long-term regardless of how long you held the property.

Publication 551, Basis of Assets, works through an example with business property bought for $30,000 and worth $60,000 at the owner’s death. A survivor who paid none of the purchase price ends up with a basis of $54,000: the value at death minus depreciation taken previously. The heir’s starting point comes from the value at death. If an estate tax return is filed, the heir’s basis has to match the value finally determined for estate tax purposes.

Revocable Trusts Keep the Step-Up, Irrevocable Gifts Usually Lose It

The step-up turns on one question: is the interest included in the owner’s estate at death? Section 1014(b)(9) covers property required to be included in determining the value of the decedent’s gross estate. Under 26 U.S.C. § 2038(a), any property the owner could still alter, amend, revoke, or terminate at death is included. A revocable living trust fits this description, so a partnership interest held in one generally gets the step-up.

An irrevocable trust funded with a completed lifetime gift works the other way. That interest generally stays out of the estate, and under 26 U.S.C. § 1015(a) the heirs take the same basis as the donor. The trade-off: the irrevocable gift moves future growth out of a large taxable estate, while the revocable trust keeps the income tax reset. Families below the estate tax threshold usually come out ahead with the step-up. Larger estates have to weigh the two.

Successor Trustee and Operating Agreement Keep the Doors Open

A funded revocable trust skips probate for the assets it holds. When the owner dies, the successor trustee he named takes control of the partnership interest right away and votes it, signs for it, and distributes it under the trust’s terms. Pick someone the other partners will work with.

The operating agreement can override all of that. Many agreements limit transfers, require consent before a trust or heir becomes a full partner, and set buy-sell terms that force a sale at death. Retitling the interest into the trust without the required consent can leave the trust holding only an economic interest with no vote. Get written consent when you fund the trust, and make sure the buy-sell clause fits the plan to keep the business in the family.

Partnership Needs a Section 754 Election

The step-up applies to the heirs’ outside basis, meaning their basis in the partnership interest, while the partnership’s inside basis in its own buildings, equipment, and receivables stays where it was. Under 26 U.S.C. § 743(a), inside basis does not adjust after a partner dies. A Section 754 election must be in effect, or the partnership must have a substantial built-in loss.

With the election in place, Section 743(b) adjusts inside basis with respect to the transferee partner only. The election applies to the year it is filed and all subsequent taxable years. Without it, the heirs can pay tax on gains their own step-up was supposed to wipe out.

Five Decisions to Make Before Your Next Tax Attorney Meeting

• Trust type: revocable for the step-up, irrevocable for estate tax reduction, or a mix of both.
• Funding: confirm the partnership interest is actually assigned to the trust and recorded on the partnership’s books.
• Operating agreement: transfer restrictions, consent to accept the trust and heirs, and buy-sell triggers.
• Successor trustee: a named primary and backup, with authority to vote the interest.
• Section 754: whether the partnership will file the election in the year of death, and who on the CPA team owns that deadline.

Estate paperwork is the part that decides whether your money ends up with family or with lawyers, and we put the full checklist, from beneficiary forms to titling, in a free estate planning guide here.

A CPA and estate tax attorney can fit these pieces to your own estate size and state.

Keep the interest in the estate through a funded revocable trust, have the partnership file a Section 754 election, and your heirs start at fair market value instead of your original cost.

Contact [email protected] for any questions or corrections.