Module 9

Basis Adjustments


 

Section A...General Theory

Required Code & Regulation Readings
 

Please browse the following statutory provisions

 

Code Sections
Regulations

734, 743, 754

1.754-1

   

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Basis adjustment rules are designed to equalize 'inside basis" (the partnership's basis in partnership property) and "outside basis" (the partners' basis in their partnership interests). The fundamental reason for the basis adjustment rules is to alleviate distortions in the timing and character of income, as well as, in some instances, the overall amount of income or loss. Differences between "inside' and "outside" basis arise as a result of several events.
  1. Death: Because the basis of a decedent's assets generally are adjusted to the fair market value at the date of death under IRC Section 1014.
  2. Sale or exchanges: Because the outside basis to a purchaser of a partnership interest is its cost, which is not necessarily the same as the basis to the partnership.
  3. Distributions: Because, in some distributions, the distributed property does not retain its previous basis, or, gain or loss might be recognized by the distributes.

Prerequisites to a basis adjustment

The general rules providing for basis adjustments are found in Sections 734 and 743, and can be divided into two categories:

  • Those adjustments made by the partnership
  • Those adjustments made by the transferee partner

Although the general rules state that no adjustment is to be made to the partnership's basis in its property, an exception to the "no adjustment' rule is provided under Section 734(b) and 743(b), which require a Section 754 election to be in effect. If the election is in effect, the partner or the partnership, depending upon the circumstances, will be able to equalize "inside" and "outside" basis.


Section 754 election

The partnership may make an election to adjust the basis of partnership property by filing a written statement with the partnership return for the year in which a transfer occurs. In order for an election to be valid, the partnership return must be filed in a timely manner, including extensions. The written statement that is filed with the partnership return must include the following information:

  • The name and address of the partnership making the election
  • A declaration that the partnership elects, under Section 754, to apply the provision of Section 734(b) and 743(b)
  • The signature of one of the partners Reg. Sec. 1.754-1(b).

The IRS will consider a request for an extension of time to make the election when the failure to make the timely election was due to a sale or exchange following the death of one of the partners. The partnership must show good cause for the failure to elect and must act within a reasonable period of time under the circumstances. Rev. Rul. 86-139, 1986-2 C.B. 95.

A Section 754 election applies to transfers under Section 743(b) and distributions under Section 734(b). It cannot apply to one section and not the other. In addition, the election not only applies to increase the basis of assets, but also applies to reduce the basis of assets as well. Reg. Sec. 1.754-1(b).

Once a valid Section 754 election has been made, it continues to be effective until it is revoked. A revocation is not automatic and requires the consent of the local district director of the IRS before it can be done. The application to revoke the election must be made no later than 30 days after the close of the taxable year for which the revocation is intended to take effect. The application must be signed by one of the partners.

Examples that are considered to be appropriate for revoking a Section 754 election include:

  • A change in the nature of the partnership business
  • A substantial increase in the assets of the partnership
  • A change in the character of the partnership assets
  • An increased frequency in the sales or retirements of partners that might cause administrative burdens

A partnership will not be allowed to revoke the election if the purpose of the revocation is to prevent the partnership from reducing its adjusted basis in partnership property. Reg. Sec. 1.754-1(c).

Considerations in making the election The following consideration should be taken into account before a partnership files a Section 754 election.

  1. Mandatory application: Once the election is effective, both Section 743(b) and 743(b) adjustments are mandatory in succeeding years.
  2. Possible basis reductions: Consideration should be given to the potential for subsequent downward adjustments to basis and the effect it might have on prospective buyers of a partnership interest.
  3. Compliance costs: Substantial additional record keeping may be required, causing increased administrative costs.

Study Questions Make your selection by clicking the appropriate response letter.

1.

Differences between "inside" and "outside" basis can result from all of the following, except:

 
Death of a partner
 
A contribution by a new partner.
 
A sale of a partnership interest.
 
A distribution of depreciated property.

2.
Which of the following statements is not true concerning the making of a valid Section 754 election?
 
The election serves to increase and reduce the basis of assets.
 
A valid election is effective until it is revoked.
 
A partnership can revoke the election to keep from reducing the basis of assets.
 
The election requires the signature of one of the partners.

3.

Which of the following would not be a consideration in making a Section 754 election?

 
The year-end of the partnership.
 
The mandatory application of the election.
 
The potential for downward adjustments.
 
The additional record keeping that may occur.

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