Partnership §754 Election: Basis Step-Up on Transfers & Deaths

§743(b) on Sales • §734(b) on Distributions • Sticky Election • §732(d) Special Basis Rule • No Election Trap
IRC §754IRC §743(b)IRC §734(b)
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When a partner sells their partnership interest or dies, the inside basis of the partnership's assets does not automatically step up to reflect the price the buyer paid. Without a §754 election, a buyer who pays $500,000 for a partnership interest - reflecting underlying assets worth $500,000 but with a tax basis of $200,000 - inherits a $300,000 built-in gain they did not create. The §754 election allows the partnership to adjust the inside basis of its assets to match what the new partner paid, eliminating the duplicate gain. The election is sticky - once made, it applies to all future transfers unless the IRS consents to revocation.

Two Types of §754 Adjustments

§743(b) - Transfers of partnership interests: When a partnership interest is sold, exchanged, or inherited (including death), the partnership may adjust the basis of its assets with respect to the transferee partner only. The adjustment equals the difference between the transferee's outside basis and their share of inside basis. A buyer who pays $500K for an interest with $200K of inside basis gets a $300K §743(b) basis increase allocated to the underlying assets.

§734(b) - Distributions: When a partnership makes a distribution that causes a partner to recognize gain or loss, or when the distributed property's basis differs from its inside basis, §734(b) adjusts the partnership's remaining assets to prevent distortion. This is less common but critical when appreciated property is distributed.

Why the §754 Election Matters for Buyers

Consider a two-partner real estate partnership that owns a building with a $2 million FMV and a $500,000 tax basis. Partner A sells their 50% interest to Buyer for $1 million (50% of FMV). Buyer's outside basis is $1 million. Buyer's share of inside basis is $250,000 (50% of $500,000). The inside-outside basis disparity is $750,000.

Without a §754 election: when the partnership eventually sells the building, Buyer recognizes $750,000 of gain they did not economically earn - they paid fair market value for their interest, but the inside basis has not been stepped up. They are taxed on appreciation that occurred before they joined the partnership.

With a §754 election: the partnership makes a §743(b) adjustment of $750,000 allocated to Buyer's share of the building's basis. When the building is sold, Buyer's share of the gain is reduced by $750,000. Buyer pays tax only on post-purchase appreciation - economically the correct result.

In practice, sophisticated buyers of partnership interests always request a §754 election before closing or verify one is already in place. A partnership without a §754 election selling a significant interest to a third party should expect the buyer to demand the election as a condition of the transaction. The cost is minimal (an annual computation and allocation); the benefit to the buyer is potentially hundreds of thousands of dollars of avoided tax on pre-acquisition gains.

The Sticky Election Rule

Once a §754 election is made, it applies to all subsequent transfers and distributions - not just the one that prompted the election. A partnership that makes the §754 election in 2026 because Partner A sold their interest must continue making §743(b) and §734(b) adjustments for all future transfers. The election cannot be selectively applied or revoked without IRS approval, which requires a sufficient reason (for example, a change in the nature of the business, a substantial increase in assets, or increased administrative burden from frequent transfers) and is not granted when the purpose is primarily to avoid stepping down basis (Treas. Reg. §1.754-1(c)(1)). Partnerships should carefully consider whether they want a permanent §754 election before making it.

The §732(d) Special Basis Rule: When No §754 Election Exists

If a partnership does not have a §754 election in place when a partner acquires their interest, and the partnership subsequently distributes property to that partner within two years of the acquisition, §732(d) provides a special rule. The distributee partner may elect to treat the distributed property as if the partnership had a §754 election in effect at the time of the acquisition - getting a basis step-up on the distributed property equal to what they would have received under §743(b). This is a transitional protection for buyers who acquired interests in partnerships without §754 elections.

Mandatory Basis Adjustments: Substantial Built-In Loss or Basis Reduction

Even without a §754 election, a §743(b) adjustment is mandatory on a transfer if the partnership has a substantial built-in loss immediately after the transfer - the partnership's adjusted basis in its property exceeds fair market value by more than $250,000, or the transferee partner would be allocated a loss of more than $250,000 if the assets were sold for fair market value (IRC §743(a), (d)). A §734(b) adjustment is likewise mandatory on a distribution with a substantial basis reduction, meaning the sum of the §734(b)(2)(A) and (B) amounts exceeds $250,000 (IRC §734(a), (d)). These rules address built-in losses only; a built-in gain disparity, however large, is adjusted only if a §754 election is in effect.

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Authority: IRC §754 (election to adjust basis of partnership property - once made applies to all subsequent transfers and distributions; revocation requires IRS consent; election made by filing statement with partnership return for year of transfer); IRC §743(b) (adjustment to basis of partnership property on transfer of interest - equals excess of transferee's outside basis over share of inside basis; allocated among partnership assets using §755 rules; applies to transferee partner only); IRC §734(b) (adjustment to basis of undistributed partnership property on distribution - triggered by partner gain or loss recognition on distribution, or when distributed property basis differs from inside basis); IRC §743(a), (d) and §734(a), (d) (mandatory basis adjustment - applies only to a substantial built-in loss or substantial basis reduction exceeding $250,000; required regardless of §754 election); IRC §732(d) (special basis rule - distributee partner may elect to treat distribution as if §754 election were in effect at time of acquisition; available for distributions within 2 years of interest acquisition; protects buyers who acquired interests without §754 election); IRC §755 (rules for allocation of basis adjustments - §743(b) and §734(b) adjustments allocated first between the two classes of property - capital assets and §1231(b) property (capital gain property) and all other property (ordinary income property) - and then among the items within each class); Treas. Reg. §1.754-1 (§754 election mechanics - statement attached to timely filed return; describes applicable transfer or distribution; sticky - applies to all future events).