By Tom Ochsenschlager, J.D., CPA
The IRS recently issued final regulations regarding the requirements for partnerships to make a section 754 election. The major change from the proposed regulations is that the final regulations remove from regulation 1.754-1(b) the requirement that a partner had to sign the election statement in order to implement the 754 election. This change is effective for tax years ending on or after the Aug. 5, 2022.
As in the proposed regulation, once the election is made, it is applicable to the beginning of the year in which it is filed and all subsequent years until the partnership revokes the election.
The 754 election is particularly important where a partnership has a low basis in its assets that have appreciated to a high value when a new partner enters the partnership.
For example, let’s say five partners each contribute $100,000 for their partnership interest and that the $500,000 is used to acquire land. After several years, the land appreciates in value to $1 million. If a new partner acquires one of the five partners’ interest in the partnership for $200,000 (1/5 of the $1 million value) without a 754 election, the new partner acquires the selling partner’s share of the partnership’s basis in the property - $100,000. The new partner steps literally in the shoes of the partner who sold his/her interest. And therefore, if the property is sold for $1 million, all the partners, including the new partner who acquired his/her interest for $200,000, would have a gain of $100,000. A 754 election enables the partnership to increase its “inside” basis for the property as $200,000 for just the new partner and, accordingly, the partnership would report no gain from the sale for the new partner. In effect, the 754 election equates the partnership’s inside basis for the partner’s “outside” basis.
The revised regulations make this fairness result more efficient by making the 754 election easier.