Section 754 election is a tax provision for partnerships and limited liability companies (LLCs) that adjusts the tax basis of partnership assets during specific events, such as transfers of partnership interests or property distributions. This election aligns the tax basis of property with its fair market value, affecting the partners involved.
Legal Basis
The legal foundation for the Section 754 election is established in the Internal Revenue Code (IRC) under Section 754. This provision permits partnerships to adjust the basis of their property in connection with property distributions and transfers of partnership interests, and it states that a properly filed election applies to the year filed and all subsequent years until revoked. 1Legal Information Institute. 26 U.S. Code § 754
Treasury Regulations provide detailed guidance on the election’s procedural requirements and circumstances for implementation. Court decisions have addressed timing, validity, and calculation issues over the years. Partnerships should maintain accurate records and consult tax professionals when considering this election.
Eligibility Criteria
Eligibility for a Section 754 election arises when specific transactions occur, such as the transfer of a partnership interest by sale, exchange, or upon a partner’s death. These situations often create disparities between the inside and outside basis, necessitating adjustments to align the tax basis with fair market value. Additionally, eligibility extends to property distributions that can trigger basis adjustments under the related rules.
A “substantial basis reduction” for distributions is defined by statute as more than $250,000. In that case, the partnership must adjust the basis of its property even if it has not made a Section 754 election. 2Legal Information Institute. 26 U.S. Code § 734
For transfers of partnership interests, if the partnership has a “substantial built-in loss,” the partnership must make a basis adjustment even without a Section 754 election. 3Legal Information Institute. 26 U.S. Code § 743
While the criteria for eligibility are clear, partnerships must carefully evaluate the long-term tax implications of making the election. While it can provide immediate tax benefits, such as increased depreciation deductions, it also introduces complexity in tax reporting and future transactions. Consulting with tax advisors is essential to determine the election’s suitability.
Filing Procedures
To make a Section 754 election, the partnership must attach a statement to its timely filed tax return, including extensions, for the year of the distribution or transfer. The statement must include the partnership’s name and address and a declaration that the partnership elects under Section 754 to apply Sections 734(b) and 743(b). 4Internal Revenue Service. Instructions for Form 1065
The IRS does not provide a specific form for this election, so the statement must meet all IRS guidelines.
The election must be made with the return for the year of the triggering event. Partnerships should maintain detailed records of the election and the resulting basis adjustments, including calculations and valuations, to ensure compliance and facilitate audits if necessary.
Basis Adjustments
The Section 754 election enables adjustments to the tax basis of partnership property, affecting both the inside and outside basis.
Inside Basis
The inside basis refers to the partnership’s basis in its assets. When a partnership interest is transferred and a Section 754 election is in effect, the partnership makes a Section 743(b) adjustment that increases or decreases the basis of partnership property with respect to the transferee partner only; it does not change the common (shared) basis used for other partners. 5Legal Information Institute. 26 CFR § 1.743-1
Outside Basis
The outside basis represents a partner’s basis in their partnership interest. A buyer’s outside basis generally equals the amount paid (plus share of liabilities), while Section 754/743(b) works on the inside basis at the partnership level “with respect to” the transferee partner. The election does not itself change a partner’s outside basis, but it affects the partner’s tax results by aligning the transferee’s share of inside basis with what they paid.
Partner-Level Impacts
The Section 754 election influences a partner’s tax liabilities by altering their share of income, deductions, and credits. Adjustments to the inside basis can increase depreciation or amortization for the transferee, reducing taxable income, while they also affect the calculation of gain or loss when the partnership sells adjusted assets. Partnerships must communicate these adjustments to partners promptly to ensure accurate tax reporting and compliance. Clear communication also fosters transparency and trust among partners.
Revoking the Election
While a Section 754 election can offer tax benefits, partnerships may find it less advantageous over time due to administrative burdens or changing circumstances. Revocation requires IRS approval. The IRS directs partnerships to request revocation on Form 15254 and file the request no later than 30 days after the close of the partnership year for which the revocation is intended to take effect. 6Internal Revenue Service. FAQs for IRC Sec. 754 Election and Revocation
To revoke the election, the partnership must file a formal request with the IRS, including a detailed explanation and supporting financial data. For example, if the costs of maintaining the election outweigh the tax benefits, this rationale should be documented. The IRS may charge a user fee for processing the request, and the review process can take several months, so advance planning is essential.
If the revocation is approved, the partnership must adjust its tax reporting accordingly, ceasing basis adjustments under Sections 743(b) and 734(b) for future transactions. Partners should be informed of the revocation and its potential tax implications, such as changes to depreciation deductions.