Potentially—but a cost segregation study does not itself create a Section 743(b) step-up. After you buy an interest in a real estate partnership, an effective Section 754 election generally permits a buyer-specific adjustment that reconciles your outside basis with your share of the partnership's inside basis. A mandatory adjustment can also apply in a substantial-built-in-loss case. Section 755 then allocates the adjustment among actual partnership assets. A defensible study may help identify shorter-lived components, but it cannot move the whole adjustment out of land or building by preference, and it does not give the other partners the same deduction. The IRS Form 1065 instructions state that Section 743(b) affects only the transferee's basis in partnership property.
Before paying for a study or accepting a projected tax benefit in the purchase price, review the transfer documents, Section 754 status, debt allocations, the partnership's asset ledger, and the buyer's expected use of any deduction. AE can coordinate the partner-specific basis and depreciation review with the partnership return and proposed study.
First, confirm there is a transfer-year adjustment
A purchase of a partnership interest differs from the partnership buying a building outright. Your purchase price helps establish outside basis in the interest; it does not automatically raise the common tax basis of every partnership asset. Section 743(b) generally measures a transferee-specific difference between the buyer's basis in the interest and the buyer's share of the partnership's adjusted inside basis, with partnership liabilities and other details included in the actual computation. The adjustment can be positive or negative. Do not equate it with the selling partner's taxable gain or with the cash purchase price alone. See the Form 1065 instructions and the Section 734(b) versus 743(b) comparison.
Check whether a Section 754 election was already in effect for the transfer year. If not, a partnership generally makes the election by attaching a statement to its timely filed Form 1065, including extensions, for a year with a qualifying transfer or distribution. The old claim that every buyer has “three years and 75 days” to elect is wrong. IRS Section 754 FAQs explain ordinary timing and potential late-election relief; AE's missed-election guide addresses that separate problem. Even without an election, a mandatory Section 743(b) adjustment can arise from a substantial built-in loss under Section 743(d); it is not a guaranteed positive buyer step-up. IRS substantial-built-in-loss guidance explains the exception.
Then allocate the buyer-specific amount to the right assets
Section 755 allocation uses the partnership's asset values, tax bases, and applicable ordinary-income and capital-gain classes. For a real estate partnership, the file may include land, the building, site improvements, furniture, equipment, and other items. Land does not become depreciable because a study found valuable improvements nearby. A cost segregation report can help support component identification and valuation, but it must be integrated with the Section 755 calculation, not substituted for it. The IRS Cost Segregation Audit Techniques Guide describes audit considerations for asset classification and supporting records.
Illustrative buyer-only schedule: Assume the buyer's properly calculated outside basis is $900,000 and share of common inside basis is $500,000, yielding a positive $400,000 Section 743(b) adjustment with an effective election. A supportable Section 755 allocation might assign $80,000 to land, $250,000 to building property, and $70,000 to qualifying shorter-lived assets. Those figures are hypothetical, not elective percentages. The $80,000 land portion produces no depreciation; the recovery treatment for the other amounts depends on each asset and the governing rules. The remaining partners continue using their existing common-basis schedules. If liabilities, values, or asset classes differ, the $400,000 amount and its allocation must be recomputed.
Does the step-up qualify for bonus depreciation?
Do not promise an immediate deduction merely because a study identifies five-, seven-, or fifteen-year property. The partnership and buyer must test the applicable-year bonus-depreciation law, property eligibility, acquisition and placed-in-service facts, and the transferee's prior depreciable interest in the acquired portion. The IRS's final Section 168(k) regulations specifically address Section 743(b) adjustments and prior-interest restrictions. A buyer who already owned part of the partnership may face a different result from a completely new buyer. The study's classification, bonus eligibility, and whether the buyer can currently use a loss under basis, at-risk, and passive-activity rules are three separate questions.
Make sure Form 1065 and the K-1 carry the buyer's adjustment
The partnership, not just the buyer's personal preparer, needs the transfer-year computation and asset allocation. The Form 1065 instructions require a transfer-year statement identifying the transferee, computation, and properties receiving the adjustment. They also direct partnerships to report the effects on Schedule K and the transferee's Schedule K-1, with Section 743(b) detail on line 20, code U, and an attached asset-category statement net of cost recovery. The partner's K-1 instructions explain that the related depreciation adjustment follows the character of the underlying partnership item on the owner's return. Do not book the step-up into every partner's tax-basis capital account or send an unsupported extra depreciation number only to the buyer's Form 1040.
Track the adjustment asset by asset after the initial year. It affects future depreciation and, when property is sold, the transferee's share of gain or loss. An untracked balance can create a double deduction or cause the buyer to pay tax on gain that their special basis should have offset. A Section 734(b) distribution adjustment is a different common-basis mechanism and should not be used as the buyer's Section 743(b) schedule.
Decision file to assemble before a study or return amendment
- Executed interest-purchase agreement, transfer date, closing statement, and any seller debt or payment adjustments.
- Transfer-year and prior Forms 1065, Section 754 election statement, buyer and seller Schedules K-1, and partnership liability schedules.
- Asset-level inside-basis ledger, depreciation schedules, valuations, existing study, and land/building/improvement allocation support.
- Section 743(b) computation, Section 755 allocation, projected cost recovery, and K-1 statement before and after the proposed study.
- Buyer-specific basis, at-risk, passive-loss, state-tax, and eventual-sale assumptions used to value the expected deduction.
Common failures before filing
- Giving the benefit to all partners. Section 743(b) belongs only to the transferee; other owners do not receive the new buyer-specific depreciation.
- Assuming the election is permanent or irrevocable without nuance. An effective Section 754 election continues for later qualifying transactions but may be revoked with IRS permission. A missed election has its own relief rules and deadlines.
- Calling the full purchase premium depreciable. Outside basis, liabilities, inside basis, Section 755 allocation, and land can make the actual depreciable amount much smaller—or produce a downward adjustment.
- Promising automatic bonus depreciation. Shorter recovery life is not the same as bonus eligibility or a currently usable loss.
- Leaving the K-1 and sale ledger unchanged. The partnership must report the transferee-specific effects and track remaining asset-level basis through disposition.
This is a federal decision framework, not a tax position for every partnership interest purchase. Debt sharing, tiered entities, prior ownership, special allocations, state conformity, and later transactions can change the result. AE Tax Advisors can review the proposed purchase or filed partnership return, coordinate a study only where it adds defensible detail, and map the buyer's return and K-1 correction path.