Section 754 Elections: When Your Partnership Should (and Shouldn't) Make One

A Section 754 election allows a partnership to adjust the tax basis of its assets when a partner sells their interest or when a partner dies. It is one of the most commonly discussed elections in partnership tax, and it shows up in operating agreement discussions regularly. Whether your partnership should make the election depends on the specific circumstances of the deal.

What Does a 754 Election Do?

When a partner buys an interest in a partnership, they pay a purchase price that may be higher or lower than the partnership's existing tax basis in its assets. Without a 754 election, the new partner takes on the partnership's existing basis. With the election, the partnership makes a basis adjustment that aligns the new partner's share of asset basis with what they actually paid.

This adjustment is called a 743(b) adjustment. It applies only to the transferee partner. It does not affect the other partners' shares of basis.

The same concept applies when a partner dies. The deceased partner's interest receives a step-up (or step-down) in basis to fair market value. A 754 election allows the partnership to make a corresponding adjustment to the assets so the heir's share of partnership basis reflects the stepped-up value.

When Does a 754 Election Make Sense?

Buying into an appreciated partnership. If a new partner pays more than the partnership's existing basis in its assets, the 754 election creates a basis adjustment that reflects the difference. This allows the new partner to accelerate tax benefits through additional depreciation or amortization on their share of the partnership's assets. The election bridges the gap between what the partner paid for their interest and the partnership's lower recorded basis.

Death of a partner. The step-up in basis at death is one of the most significant tax benefits available. A 754 election allows the partnership to adjust its asset basis so the heir can recognize the tax benefit of that step-up through additional depreciation or reduced gain on a future sale.

Partnerships with significant appreciation. If the partnership holds appreciated assets, a 754 election allows an incoming partner to recognize the tax benefit of their higher outside basis. The 743(b) adjustment gives the new partner additional depreciable basis equal to the difference between what they paid and their share of the partnership's existing inside basis.

When Might a Partnership Not Want One?

A 754 election is irrevocable once made. It applies to all future transfers, not just the one that triggered it. That means the partnership must track basis adjustments for every partner individually, for every future transfer or death.

For partnerships with frequent transfers or many partners, the administrative burden can be significant. Each transfer requires a new 743(b) calculation, and the partnership must maintain separate basis records for each partner.

There are also situations where a 754 election produces a basis step-down rather than a step-up. If a partner sells their interest at a loss, the election reduces the incoming partner's share of asset basis. The partnership cannot selectively apply the election to favorable situations only.

What Should the Operating Agreement Say?

Some operating agreements require the partnership to make a 754 election. Others leave it to the discretion of the managing partner or general partner. Both approaches have trade-offs.

A mandatory election ensures consistency and protects incoming partners. A discretionary approach gives the partnership flexibility to evaluate each situation. The operating agreement should address who has the authority to make the election and under what circumstances.

I covered how operating agreement provisions drive tax outcomes in What Your Attorney Writes vs. What Your CPA Needs. The Decision Matrix helps identify which provisions fit your deal structure.

This post is educational and does not constitute tax or legal advice. Consult your CPA or tax advisor for guidance specific to your situation.

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