Inheriting a Business Interest: Tax Rules, Options & What to Do

A business interest can be the most complex asset in an inheritance — and the most time-sensitive. Step-up in basis can eliminate embedded gains, but S-corps, partnerships, and family businesses each have different rules. Here's how to think through what you have and what comes next.

What type of business interest did you inherit?

The rules — and your options — differ significantly by entity type:

• Sole proprietorship: Business assets pass directly through the estate and get a step-up in basis under IRC §1014. There is no separate entity — you inherit the assets themselves.
• Partnership or multi-member LLC: You inherit a partnership or membership interest. Step-up applies to your outside basis in the interest, but whether it carries through to the partnership's underlying assets depends on whether a §754 election is in place.
• S-corporation: You inherit stock. Your outside basis steps up to date-of-death fair market value. But unlike partnerships, S-corps cannot make a §754 election — the inside basis of corporate assets does not automatically adjust.
• C-corporation: Same step-up on stock as an S-corp. Capital gains rates apply on future appreciation above the stepped-up basis.
• Family farm or ranch: Often organized as a partnership, LLC, or sole proprietorship, with additional planning tools available under IRC §2032A.

Step-up basis on business assets: what gets reset

Under IRC §1014, inherited assets receive a new cost basis equal to fair market value (FMV) on the date of death.¹ For a sole proprietorship or directly inherited assets, the step-up applies asset by asset:

• Tangible assets (equipment, machinery, real estate, vehicles): Full §1014 step-up. Embedded gains are erased — and so is prior depreciation recapture exposure in many cases. The new basis resets the depreciable life going forward.
• Goodwill: Gets a step-up. If the business's value is tied to the owner's relationships, reputation, or trade name, that goodwill has a value at death — and you receive it at the stepped-up FMV.
• Cash and bank accounts: No embedded gain; step-up is irrelevant here.
• Accounts receivable: No step-up. These are "income in respect of a decedent" (IRD) under IRC §691 — the decedent earned the income but had not yet received it. When the business collects the invoices, that income is taxable to you at ordinary rates.
• Inventory: Generally no step-up; ordinary income when sold. Inventory is held primarily for sale in the ordinary course of business, not for investment.
• Installment sale obligations: Also IRD — collections are ordinary income as received.

Partnerships and LLCs: the §754 election

When you inherit a partnership or LLC interest, your outside basis (the tax basis in your membership interest) steps up to FMV at death under §1014. But the partnership's inside basis — the tax basis in the underlying assets — doesn't automatically adjust to match.

Without a §754 election: Your outside basis reflects the stepped-up value, but when the partnership sells an appreciated asset, you're taxed on embedded gain you never actually experienced — you effectively pay tax on appreciation that occurred before you inherited.

With a §754 election (and the corresponding §743(b) basis adjustment): The partnership adjusts its internal asset basis for your specific ownership share, eliminating the mismatch.² If the partnership had sold those assets the day after you inherited the interest, your portion of gain would be near zero — your inside basis matches your outside basis.

Key points about the §754 election:

• The election is made by the partnership, not by you individually. You may need to request it — the existing partners must agree, and it is filed with the partnership's Form 1065 for the year of the triggering event (the death).
• Once made, the §754 election is permanent and applies to all future partner transfers and distributions — not just your inheritance.
• The adjustment is allocated specifically to you. Other partners' inside basis is not affected by your inheritance.
• The election is generally favorable if the partnership holds appreciated assets. If assets have declined in value, it also applies in reverse, which may not benefit you — evaluate the asset profile before requesting it.

If the partnership already has a §754 election on file from a prior transfer or distribution, the §743(b) adjustment is automatic when you inherit.

S-corporations: no inside basis adjustment available

This is a material disadvantage of the S-corp structure for inheritance. When you inherit S-corp stock, your outside basis steps up to FMV under §1014 — that part is the same as with any inherited stock. But S-corps cannot make a §754 election. The basis of the corporation's underlying assets does not adjust to match your stepped-up outside basis.

The practical consequence: future depreciation is computed on the old, lower asset basis, and if the corporation ever sells its underlying assets, the embedded gain flows through to you — even though you "paid" FMV when you inherited the stock.

There are structural workarounds, but they are complex and require co-owner cooperation:

• §338(h)(10) election: Available when a qualifying buyer (typically a corporation) purchases at least 80% of the S-corp stock. The transaction is treated as if the corporation sold its underlying assets directly, triggering a full basis reset — but also recognition of any embedded corporate-level gains. Economically, this is often priced into the deal.
• §336(e) election: Broader than §338(h)(10) — available for sales to non-corporate buyers in certain situations. Also triggers deemed asset sale treatment.
• Both elections require agreement of all selling parties and cause immediate gain recognition, so they are typically only used when the deal economics clearly support it.

Buy-sell agreements and what they mean for you

If the decedent had co-owners, there is likely a buy-sell agreement in place — a contract that governs what happens to a deceased owner's interest. Two common structures have very different tax consequences:

Cross-purchase agreement

The surviving co-owners personally buy out the deceased owner's interest. Life insurance is typically used to fund the buyout — proceeds received income-tax-free under IRC §101(a). The surviving owners each acquire the purchased shares at FMV (their new cost basis), reducing capital gains exposure on a future sale of the entire business.

Entity redemption agreement

The company itself buys back the deceased owner's interest using entity-owned life insurance. Also income-tax-free under §101(a). However, surviving co-owners do not receive a basis step-up in their existing shares — their original basis remains, which can create larger capital gains when they eventually sell their own interests.

From your perspective as the inheritor, the more immediate question is: what does the buy-sell agreement say about price? Agreements may set a fixed price, a formula, or trigger a fresh appraisal. If the agreed price is well below the current FMV — because the agreement is old and the business has grown significantly — you may have grounds to contest it, particularly if the agreement doesn't satisfy the §2703 requirements for respecting the agreed price for estate tax purposes.

Your decision framework

Inheriting a business interest typically leads to one of four paths:

1. Sell to co-owners per the buy-sell agreement. The most common outcome when co-owners exist. The price is pre-set or triggered by appraisal. Tax basis is stepped up to FMV at death, so gain equals (sale price) minus (FMV at death) — near zero if the sale closes promptly after inheritance.
2. Continue operating or take an ownership role. If the business has durable value — recurring revenue, key employees, customer relationships — you may want to continue it with professional management or transition in yourself. Requires careful diligence on the business's liabilities, leases, contracts, and obligations that also transfer with ownership.
3. Liquidate the business assets. If there are no co-owners and no ongoing going-concern value, sell off the underlying assets individually. Step-up basis on tangible assets means most are sold at or near their tax basis with minimal gain. Accounts receivable and inventory, however, will still generate ordinary income.
4. Hold and evaluate. Sometimes the right first move is to pause, get a business valuation, and understand what you have before committing. You generally have time to do this — buy-sell agreements specify timelines, but most give beneficiaries 60–120 days before the buyout must close.

Family farms: §2032A special use valuation

For qualifying family farms and closely-held real property used in a trade or business, the estate can elect to value the property based on its actual use — farmland valued as farmland, not as potential residential development — under IRC §2032A.³

In 2026, the §2032A election can reduce the estate tax value of qualifying property by up to $1,460,000, the inflation-adjusted limit per IRS Rev. Proc. 2025-32.⁴ For large family farms near major metropolitan areas where FMV as development land greatly exceeds farm value, this reduction can mean the difference between owing estate tax and owing nothing.

Qualification requirements:

• The property was used for farming or a closely-held business for at least 5 of the 8 years before death
• You (the qualified heir) must continue using the property for farming or the qualifying business for 10 years post-election
• Qualified real property must represent at least 25% of the adjusted gross estate; total farm and closely-held business assets must be at least 50%
• The decedent was a U.S. citizen or resident, and the property passes to a qualified heir

The 10-year continuation requirement carries a recapture tax under §2032A(c) — if you sell or stop using the property for the qualifying purpose within 10 years, you owe back the estate tax that was saved. This is a long-term commitment that should be weighed carefully against the tax benefit.

For large farm estates that also face estate tax, the §6166 installment payment election allows estate tax attributable to closely-held business interests (when that interest exceeds 35% of the adjusted gross estate) to be paid in installments over up to 14 years at preferential interest rates — preserving liquidity for the business.

Startup stock: the §1202 QSBS exclusion

If you inherited C-corporation stock that qualifies as Qualified Small Business Stock (QSBS) under IRC §1202 — typically a startup, early-stage growth company, or small operating business — a significant gain exclusion may carry forward to you.

Under the One Big Beautiful Bill Act (OBBBA, July 2025), the §1202 exclusion was raised to $15 million per shareholder per issuer, with a tiered holding-period requirement: 50% exclusion at 3+ years, 75% at 4+ years, 100% at 5+ years.⁵

For inherited QSBS, IRC §1202(g)(1) allows the decedent's holding period to tack onto yours. If the decedent held qualifying QSBS for 5+ years, you may qualify for the full 100% exclusion on gains you accumulate above your stepped-up basis going forward. The step-up itself eliminates gain below FMV at death; §1202 shelters further appreciation after you inherit.

The QSBS rules are highly technical — the corporation must have met active business and gross asset tests throughout the entire holding period, and not all C-corps qualify. Confirm QSBS status with a tax advisor before assuming the exclusion applies to your inherited shares.

What a specialist advisor does differently

A generalist sees an inherited business interest and thinks "sell it and invest the proceeds." A specialist thinks about:

• Whether the §754 election is in place for an inherited partnership — and whether to pursue it if it isn't, before the partnership files its next tax return
• Which assets are IRD (accounts receivable, inventory, installment obligations) vs. §1014 step-up assets — because they generate very different tax outcomes
• Whether the buy-sell agreement price is defensible under §2703, or whether renegotiating is possible and warranted
• Whether a §338(h)(10) or §336(e) election makes sense on an S-corp sale, given the corporate-level embedded gain and deal structure
• Whether §2032A applies for a family farm — and whether the 10-year restriction fits your plans
• How business sale proceeds interact with your broader tax picture: IRMAA brackets, Roth conversion windows, state capital gains taxes
• Whether the estate correctly documented and reported business value on Form 706 — because that reported value becomes your stepped-up basis

Related guides

• Step-Up Basis: What It Is and How to Use It — complete guide to IRC §1014, community property, alternate valuation date, and the deathbed gift trap
• Inheriting a Brokerage Account — step-up basis on publicly traded stocks and funds
• What to Do With an Inherited House — step-up basis and depreciation recapture for inherited real property
• Inheritance Tax by State: A 2026 Guide — which states tax beneficiaries directly
• What to Do When You Inherit Money — the full first-year playbook across all asset types