IRC Section 743(b) allows partnerships to make basis adjustments when a partnership interest is sold or transferred, but only if the partnership makes a Section 754 election. This provision is critical for business owners selling their partnership interest, as the step-up in basis upon transfer can be preserved within the partnership, benefiting all remaining partners (if the step-up is amortized and allocated) or creating audit exposure if improperly reported.
How Section 743(b) Basis Adjustments Work
When a partnership interest is sold, the purchasing partner pays a price based on the partnership's fair market value. However, the partnership's tax basis in its assets may differ significantly from FMV (due to depreciation deductions, prior contributions, or market appreciation). Without Section 743(b), the partnership continues depreciating assets based on the old basis, creating a mismatch between the purchasing partner's economic investment and the tax basis available for deductions.
Section 743(b) (available only with a Section 754 election) allows the partnership to adjust the basis of partnership assets to reflect the step-up or step-down from the sales price.
Inside vs. Outside Basis
Partnership interests have "outside basis" (the partner's basis in the partnership interest itself) and partnerships have "inside basis" (the partnership's basis in its assets). When a partner sells their interest, the sale price reflects the outside basis adjustment, but without Section 743(b), the inside basis (partnership asset basis) remains unchanged.
Section 754 Election Requirement
Section 743(b) basis adjustments are only available if the partnership has made a timely Section 754 election. The election must be filed with the partnership's tax return within 3 years and 75 days of the year in which the transfer occurs. Many partnerships fail to make this critical election, resulting in loss of Section 743(b) benefits.
Special Valuation Issues and Built-In Gain
Section 743(b) basis adjustments must be allocated among partnership assets based on their built-in gains or losses at the time of transfer. Partnerships with appreciated real estate and depreciated intangible assets face complex allocations under Treas. Reg. 1.743-1(b).
Key Takeaways for Partnership Buyers
- Section 743(b) allows basis adjustments upon partner transfer if Section 754 election is made
- Basis adjustments can increase depreciation deductions available to the partnership
- Section 754 election is permanent (cannot be revoked except by IRS permission)
- Basis adjustments must be carefully allocated among partnership assets
- Failure to make Section 754 election results in permanent loss of basis adjustment benefits
The Bottom Line
Partnership interests should be purchased with Section 754 election status verified. Buyers paying premium prices for partnership interests should ensure the partnership has made (or will make) Section 754 election to preserve basis adjustment benefits.