Don’t Overlook Section 754 Elections

DON’T OVERLOOK SECTION 754 ELECTIONS
(as published in the CPA Journal -
a publication of the New York State Society of CPAs)
By Robert S. Barnett,Esq.
Capell Barnett Matalon & Schoenfeld, LLP
100 Jericho Quadrangle, Suite 233
Jericho, New York 11753
Phone – (516) 931-8100
In our estate planning and general tax planning practices, the advantages of Section 754 Elections should not be overlooked.  These elections may be extremely beneficial to our clients who are purchasing partnership interests or who receive a partnership interest through an estate.       The Section 754 Election allows the basis of partnership property to receive a step-up (or potentially a step-down) based upon the cost of a partnership interest which is purchased or the basis of a partnership interest received by an estate.  In the context of an estate, the new basis provided to the estate will be used to increase the basis of the property inside the partner- ship.  This will provide the estate or the estate beneficiaries with either additional depreciation deductions or a reduction in the gain realized if the partnership were to sell the assets.  This is often a tremendous advantage and should not be over- looked.  For example: If partnership assets consist of rental real property which has appreciated over its book value, the Estate will receive a new increased basis for depreciation and other purposes11.       Section 74322 of the Internal Revenue Code generally describes the rules involved in the case of a sale of a partnership interest or upon the death of a partner.  The adjustment seeks to achieve a state of equilibrium for the applicable partner, equivalent in concept to that basis the partner would have received had he or she purchased those assets outright.  In addition, a Section 754 Election may also be very helpful in avoiding potential depreciation recapture produced by the sale of a partnership asset.  Without a Section 754 Election the transferee partner might be responsible to recapture a greater portion of the depreciation deductions as ordinary income than that which the particular partner has received as a benefit.
Therefore, whenever your clients are purchasing a partnership interest where depreciable property is involved, look closely to see if such an election should be made.       The Section 754 Election is made simply by filing a signed statement with the partnership tax return indicating that the partners wish to make such election and adjust the basis of partnership property as required under Section 743(b) and 734(b).  While the Election is relatively simple to make, it is extremely difficult to revoke without approval of the District Director of the Internal Revenue Service.  Revocations are generally allowed where there is a change in business or change in circumstances such as where there has been a large influx of new partners and making the Election would involve undue complexity and administrative burdens.
Once the Election has been made it applies to all partnership transfers during the taxable year and to all distributions of property by the partnership for that year – and for all succeeding taxable years.  Therefore, a downward adjustment may be required in future years even though such event is unforseen at the present time.  If the purchase price of a partnership interest is less than the purchaser’s share of the partnership’s basis in its assets, no Section 754 Election should be made – otherwise, a step-down in asset basis will occur.         Before making an Election under Section 754, it would be useful to analyze the effects of Section 732(c).  The 1997 Tax Act amended Section 732(c) which applies to allocate the basis of
assets received in a partnership liquidation.  These new rules might be more advantageous in family situations where assets may be distributed out of the partnership in complete liquidation and then sold or rented by the estate or distributee of the estate.

Don’t Ovrlook Sect.
Articles (10.23.98)
for IAFP Jan.’99