Section 754 election
From Wikicpa
A Code Section 754 election is made to eliminate the disparity between an incoming partner's "outside" and "inside" basis. A Section 754 election, once made, applies to all future years. In some unusual cases, however, the IRS may allow an election to be rescinded.
When an incoming partner purchases an existing partner’s partnership interest (or a member in an LLC taxed as a partnership), for its fair market value, the amount paid by the incoming partner is the basis for the purchaser’s partnership interest "outside basis". The new partner takes over the selling partner's prorata share of the partnership’s adjusted basis in its property. This is the new partner's "inside basis". If the partnership’s assets have appreciated sufficiently, the difference between the new partner’s "inside" and "outside" basis can be substantial. This difference can result in the new partner receiving lower depreciation deductions and overstate his or her share of the gain resulting from a future sale of the assets.
If a partnership makes a Code Section 754 election, the disparity between the inside and outside basis will be resolved so that the buying partner will be treated as if he or she had purchased an undivided interest in each asset. The basis of the assets will be adjusted in accordance with Code Sections 743(b) and 755.
The same type of adjustment to the basis of the assets in the partnership/LLC will be made when an interest in a partnership (or an LLC treated as a partnership) is inherited. In that case the outside basis is determined by the value of the partnership/LLC interest at the time of the prior partner's death, and the inside basis will be adjusted if a Section 754 election is - or has previously been - made.
- Note: if no election is made, when the assets are sold, the purchasing partner will initially be overtaxed, some of which may result in the recognition of ordinary income. However, since that partner's outside basis will be increased by the amount overtaxed, the partner will be eventually be entitled to an offsetting loss deduction when the partner disposes of his partnership interest, which could result in a capital loss.
Technical termination
If the sale of the partnership interest is greater than 50%, the sale will result in a technical termination of the partnership. This does not result in a termination under state law and the entity can retain the same taxpayer identification number.
Upon the deemed termination, the partnership's taxable year will close on the date of sale. Under Treasury Regulations, the terminated partnership is deemed to have transferred its assets and liabilities to a new partnership. The "new" partnership must adopt a new taxable year, which is usually the calender year, by filing IRS Form 1128, Application to Adopt, Change or Retain a Tax Year.
Sample election
Election to Adjust Basis of Partnership Property
IRC Section 754(d) Taxpayer Name: Taxpayer ID Number: Year-end:DECEMBER 31, 2007
Section 754 Election Pursuant to IRC Sec. 754 and Reg. 1.754-1(b)(1), the partnership hereby elects to adjust the basis of partnership property as a result of a distribution of property or a transfer of a partnership interest as provided in IRC Sees. 734(b) and 743(b).
General Partner: _________JILL MOODIE_______________ Date: MAY 1, 2007_______________________________________________
Statement Regarding Section 743 Adjustment (Pursuant to Reg. 1-743-1(b)(3))
Taxpayer Name: Taxpayer ID Number: Year-end:
For its tax year ended DECEMBER 31, 2007 FIN (insert ID number), made an election under IRC Sec. 754 to adjust the basis of partnership property.
The taxpayer acquired a (insert %), interest in the above named partnership on_________.
Total increase in basis of property as computed under Reg. 1.743-1. $ xxx,xxx
Allocation of basis adjustment to partnership properties Equipment $50000 Building xx,xxx Land improvements xx,xxx Total $xxx,xxx
