Section 754 Elections

John, a white man with dark brown hair, wears a pale blue shirt, lime green and blue tie, and black suit. Savannah, a white woman with lon gblond hair, wears a pale grey blouse and a black jacket. By John G. Hodnette and Savannah Rankich

A partnership may elect to adjust its inside basis under Sections 734(b) and 743(b) by making a Section 754 election with the partnership’s annual tax return. The basis adjustment occurs, however, only when there is (1) a distribution of partnership property or (2) a transfer of partnership interest. 754 elections can be extremely valuable because they provide the possibility of an increase in the inside basis of partnership assets.

If a 754 election is made, when a partnership distributes property to a partner, the partnership’s inside basis is increased pursuant to Section 734(b), by (A) gain recognized by the distributee partner and (B) in the case of non-liquidating distributions of property other than money, by the excess of the adjusted basis of the distributed property to the partnership over the basis of the distributed property to the distributee.  Similarly, a partnership’s inside basis is decreased by (A) loss recognized to the distributee partner and (B) in the case of liquidating distributions of property other than money, by the excess of the basis of the distributed property to the distributee over the adjusted basis of the distributed property to the partnership.

If a 754 election is made, when a transferee partner’s basis in his partnership interest is greater than his proportionate share of the adjusted basis of the partnership property, the partnership increases the adjusted basis of the partnership interest under Section 743(b) by such difference. If the outside basis is lesser than the inside basis, the partnership decreases the adjusted basis by the difference. This increase or decrease only adjusts the basis of the transferee partner and is referred to as a special basis adjustment. After such adjustment, depreciation is determined separately for the transferee partner. Section 743 applies when the outside basis of a partnership interest differs from the partner’s share of inside basis, including when there is a sale or exchange of the partnership interest or upon the death of a partner, resulting in a basis adjustment to the partnership interest pursuant to Section 1014(a).

To make a 754 election, a partnership attaches a written statement to its timely filed (including extensions) income tax return that includes the name and address of the partnership and a declaration that the partnership elects under 754 to apply the provisions of 734(b) and 743(b). An automatic 12-month extension is granted to make the election if the taxpayer takes corrective action specified in Reg. § 301.9100-2(c).

Once a 754 election is made, it applies to all property distributions and transfers of partnership interests for that year and all future years unless revoked. To revoke an election, the partnership must file Form 15254 no later than 30 days after the close of the taxable year. An election may be revoked only with IRS approval. Examples of situations where a revocation may be approved include: (1) a change in the nature of the partnership business, (2) a substantial increase in the assets of the partnership, (3) a change in the character of partnership assets, or (4) an increased frequency of retirements or shifts of partnership interests so an increased administrative burden would result from the election. Reg. § 1.754-1(c). However, a revocation will not be approved if the primary purpose is to avoid stepping down the basis of partnership assets upon a transfer or distribution. Id.

John G. Hodnette is an attorney and Savannah Rankich is a summer associate with Fox Rothschild in Charlotte.

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