Inherited Real Estate Portfolios: Basis, LLCs, and 1031 Exchanges

A portfolio of buildings does not pause for grief: rent is due on the first, roofs leak when they please, and a lease renewal can arrive in the same week as the death certificate. If your husband owned apartment buildings, shops, or offices, directly or through limited liability companies, you have inherited a small operating business along with the real estate.

The decisions fall into two groups. The first is custodial: who may sign, who manages the buildings, and whether the insurance protects the right owner. The second is strategic: what the new tax basis is worth, whether a like-kind exchange improves the portfolio or merely postpones a tax, and which buildings should simply be held. After reading, you should be able to separate what needs attention this month from the questions that belong with your attorney and tax adviser.

Establish who owns each building and who may sign

Begin with a one-page schedule: each property, the name on the deed, the owning entity if any, the lender, the manager, and the insurer. Property in your husband’s sole name, a revocable trust, joint title, or an LLC each reaches you by a different path, and that path decides who can sign a lease or a sale agreement now.

For each LLC, read the operating agreement before the rent roll. Note who is manager, what happens to a member’s interest at death, whether an heir becomes a full member or receives only the right to distributions, and whether other members hold purchase or consent rights. State LLC statutes fill gaps the agreement leaves, and they vary. If your husband was sole member and manager, ask counsel what must be signed to admit you or the estate, and update the bank’s signature cards.

Review the manager’s authority and the insurance

A property management agreement delegates your authority, and it was negotiated for someone else. Reread the spending limit, the power to sign leases, leasing and renovation fees, how deposits and operating funds are held, the reports owed to you, and how either side may end it. Ask for the rent roll, arrears, open work orders, and vendor contracts early. If you may manage a smaller property yourself, our landlord readiness guide covers screening, leases, and deposits.

Call each insurer. Confirm that the named insured is the entity or trust that actually holds title and that lenders are shown correctly. Test property limits against replacement cost, liability limits against the whole portfolio, and review loss-of-rents cover, flood exposure, and vacancy provisions. An umbrella policy that covered your husband personally may not reach buildings held through entities.

The new basis, and why depreciation starts over

Under Publication 551, inherited property generally takes a basis equal to fair market value at the date of death, or on the alternate valuation date if the executor elects it. If the estate was required to file Form 706, the value reported to you on Schedule A of Form 8971 may bind you. Title matters: for a qualified joint interest between spouses, only the half included in your husband’s estate takes a new basis; in the community property states the publication lists, both halves generally take a new basis.

The inherited value generally starts a new depreciation schedule for the inherited property; where you already held a qualified joint interest, your own half keeps its adjusted basis, including prior depreciation adjustments. Land is not depreciated, so each appraisal should allocate value between land and building. Publication 527 gives residential rental buildings a 27.5-year recovery period under the general system, uses a mid-month convention, and treats nonresidential real property as a separate class. Publication 946 says depreciation begins when property is ready and available for its income-producing use. Do not simply continue your husband’s schedule for the inherited portion. Our guides to inherited rental property basis and documenting inherited basis cover the allocation and the permanent file.

An LLC taxed as a partnership creates a second basis ledger. Your inherited partnership interest generally receives its own outside basis under the inherited-property rules, but the partnership does not ordinarily adjust the tax basis of its buildings merely because a partner died. An inside-basis adjustment may apply if a section 754 election is in effect or the partnership has a substantial built-in loss, and a section 743(b) adjustment is specific to the transferee partner. Notify the partnership and have its tax preparer analyze the election, the operating agreement, liabilities, and the filing deadline before the first post-death return.

How a like-kind exchange works

A section 1031 exchange lets you sell one business or investment property and buy another without recognizing gain now. Under the Form 8824 instructions, since 2018 the rule covers only real property, never property held primarily for sale, and U.S. and foreign real estate are not like-kind. The mechanics are exacting:

1. Identify replacement property in writing within 45 days after transferring the property you sell.
2. Receive it by the earlier of the 180th day or your return’s due date, with extensions, for the year of sale.
3. Avoid actual or constructive receipt of the proceeds. A qualified intermediary commonly holds them; your agents and related parties are generally disqualified from serving in that role.
4. Gain is taxable to the extent you receive cash or other non-like-kind property, including net relief from debt the buyer takes over.

Suppose you sell an office building on March 2. You must identify by April 16 and close by August 29. If the intermediary causes you to miss either date, the gain may be taxable in the year of sale. If instead the intermediary defaults because of bankruptcy or receivership, and you meet the requirements of Revenue Procedure 2010-14, you may be able to report the gain in the year or years you actually receive payment.

Two points matter for inherited portfolios. Partnership interests are generally excluded from section 1031, so an LLC taxed as a partnership ordinarily must exchange the building at the entity level; selling your membership interest is not a substitute. The taxpayer that transfers the relinquished property also generally must acquire the replacement property, although disregarded entities can complicate the label without changing the federal taxpayer. Set the ownership structure before listing the building. Under Publication 551, replacement property generally carries over the basis of the property given up, so the deferred gain travels with it.

Treat Delaware statutory trust offerings with caution

With the 45-day clock running, you may be offered a fractional interest in a Delaware statutory trust, or DST. Revenue Ruling 2004-86 explains why one can qualify: each investor is treated as owning an undivided fractional interest in the real estate. It also shows the price. The trustee in the ruling could not accept new contributions, renegotiate the loan, renegotiate the lease or add tenants except on the tenant’s bankruptcy or insolvency, or make more than minor non-structural changes. With broader powers, the trust would be classified as a partnership, and an interest in it would not qualify.

You would trade a building you control for a passive share of one you cannot steer. FINRA’s 2005 Notice to Members 05-18 addresses pooled tenant-in-common offerings rather than DSTs, but its due-diligence questions are useful analogies: liquidity, concentration, compensation, financing, conflicts, projections, and an exit that may depend on the sponsor. Read the DST’s own private-placement memorandum rather than assuming Revenue Ruling 2004-86 guarantees the offering’s tax result. Ask what the sponsor and broker are paid, when the loan matures, how long the main lease runs, what happens if cash flow falls short, and how you could exit.

A section 1031 exchange defers gain; it does not erase it. Any later basis adjustment at death depends on the law and ownership facts then in effect.

Passive activity rules decide when losses count

Publication 925 generally treats a rental activity as passive even if you materially participate, unless you qualify as a real estate professional: more than half of your personal services in all businesses, and more than 750 hours, in real property businesses in which you materially participate, and you also materially participate in the rental itself. With active participation, such as approving tenants and expenditures, and an interest of at least 10%, you may deduct up to $25,000 of rental losses against other income, but the allowance shrinks by half of modified adjusted gross income above $100,000 and disappears at $150,000.

Disallowed losses carry forward and are generally released when you dispose of your entire interest to an unrelated party in a fully taxable transaction, which an exchange is not. Your husband’s suspended losses are allowed on his final return only to the extent they exceed the basis increase his heirs receive. An estate is treated as actively participating for tax years ending less than two years after death if the decedent would have qualified.

The case for holding to a second step-up

Each exchange carries old basis forward. If you hold the replacement property until your death, your heirs would generally take a new basis at its fair market value, and the gain you deferred would not follow them. For a highly appreciated building, that can favor keeping it over selling or exchanging into something you understand less well.

The step-up is an income-tax benefit only. For deaths in 2026, the federal basic exclusion amount is $15,000,000, and states set their own estate and inheritance tax tests. Holding has costs too: concentration, capital needs, and heirs who may not want to be landlords. Hold because the building is sound and serves you, not merely to avoid a tax.

Questions to settle with your advisers

1. Who holds title to each building, and who may sign for each owner today?
2. What does each operating agreement say about managers, transfers at death, and new members?
3. What may the manager spend, sign, and lease without me, and how is the agreement ended?
4. Is every policy in the correct owner’s name, with liability sized to the whole portfolio?
5. What date-of-death value and land allocation will each property use, and when did each go into service for me?
6. If we sell, can we meet the 45- and 180-day deadlines, and how will the intermediary protect the funds?
7. If a DST is proposed, what are its fees, loan maturity, lease term, sponsor record, and exit?
8. Which rentals are passive, and where are suspended losses tracked?
9. Would this building serve my heirs better held to a second step-up than sold or exchanged?

This article provides general U.S. educational information and is not legal, tax, investment, insurance, or securities advice. State property, LLC, and insurance law varies. Confirm current rules with the IRS and a qualified attorney and tax adviser who know your facts.