Step It Up! (An Often-Overlooked Tax Benefit for Acquired Partnership Interests)
By John Hadwen, Tax Senior Manager
When a partnership interest changes hands, the partners should be aware of a benefit that can greatly accelerate some otherwise deferred deductions. Internal Revenue Code Section 754 allows a partnership to make an election to increase, or “step-up” the basis of the assets within a partnership when a partner’s interest is redeemed by the partnership or when a partner’s interest is purchased by another partner. This step-up in basis is used to make the inside basis (the basis of the assets in partnership) equal to the outside basis (basis of the partnership in the hands of the owner) for tax purposes. This equalization of basis can be beneficial to an owner when the step-up is deemed to be related to depreciable or amortizable property of the partnership. It will allow increased depreciation and amortization deductions starting in the year the election is made, instead of basis that will be recouped years down the road when the interest or property is sold or transferred. Generally the deductions created by the election are allocated solely to the partner who acquired the transferred shares, rather than to all partners based on whatever methods of allocation apply to the rest of the partnership’s income and expenses.
The election is filed with the tax return that covers the period in which the ownership transfer took place, and consists of a written statement signed by the tax matters partner. It is important to note that the election is in effect for the year filed and all years thereafter. It is permanent and can only be revoked with IRS consent. All subsequent redemptions and sales of interests will be subject to the election and a step-up (or step-down) must be calculated every time one of these events occurs.
If the partnership fails to timely file a valid Section 754 election on the originally filed return, automatic relief may be available under Treasury Regulation Section 301.9100-2. Under this regulation, the taxpayer is granted an automatic extension of 12 months from the due date (excluding extensions) for making certain regulatory elections.
As mentioned above, this is a permanent election that is revocable only with IRS consent. In one year there may be a step-up, making the election beneficial. However, a step-down is also possible, and if that occurs in a subsequent year, it too must be used, even though detrimental. Accounting for the election can be complicated and time-consuming, as there will be special allocations of inside basis and related deductions to specific partners which will need to be tracked and disclosed on the partners’ Schedules K-1. Furthermore, the election is an entity level election and all partners are subject to the rules (as they pertain to that specific partnership).
Partners should determine whether their partnership agreement allows or requires a Section 754 election. The election will bring some administrative burdens, but remains a very powerful tool for accelerating tax deductions after ownership changes hands.
If you would like to discuss further, please call your BNN advisor or John Hadwen at 1.800.244.7444.
Disclaimer of Liability: This publication is intended to provide general information to our clients and friends. It does not constitute accounting, tax, or legal advice; nor is it intended to convey a thorough treatment of the subject matter.