Revoking the Partnership’s Section 754 Electionby
Buying corporate stock at a relatively high basis is a potential benefit to the new shareholder, but it doesn’t impact the corporation’s tax basis, whether the entity is a C or S corporation.
When clients buy into corporate stock, it’s good to know the rules for tax planning purposes as they can be quite different with partnerships.
The partnership rules are a combination of entity and aggregate concepts. Section 754, if elected, can apply under Section 734 (distributions of partnership property) and Section 743 (transfer of an interest due to sale or death). Both Sections 734 and 743 can be important, but the most important is usually Section 743, which can adjust asset basis inside the partnership when there is a sale of a partnership interest or death of a partner.
Example: Entities A and B form partnership AB, which owns land that the partnership purchased for $500,000, which is worth $1,000,000 upon the death of A. We assume equal partners, individuals, no transactions other than the land investment, and a Section 754 election.
The land is later sold for the $1,000,000, which could yield no taxable gain to A’s successor because the land’s basis is effectively $250,000 plus $250,000 step-up, or $500,000 which is equal to the successor’s share of proceeds inside the partnership – 50 percent of $1,000,000. Due to the election under Section 754, A’s successor has $500,000 proceeds and $500,000 cost. B’s taxable gain is $250,000 - $500,000 of proceeds less $250,000 or B’s 50 percent share of the partnership’s original cost basis subtracted from B’s 50 percent share of the $1,000,000 proceeds.
Note: For some recent IRS discussions on the matter, see “Practice Units, IRS.gov, “Partner’s Outside Basis,” (6/10/21), “Sale of a Partnership Interest,” (3/12/21). The effect of the election is typically taxpayer beneficial, but it can impact the partner negatively. It can increase the partner’s gain or reduce loss.
It may have also benefitted someone last year and harm someone this year. Once made, the Section 754 election is ongoing; it applies not selectively but to all transfers of partnership interests and distributions of property in the year of election and subsequent years (Regs. Sec. 1.754-1(a)).
“Note, however, that a reduction to the inside basis of partnership assets (i.e., a negative Section 734(b) adjustment) occurs only from a liquidating distribution.” (“Consequences of a Section 754 Election,” Karen Rodrigues, Checkpoint Catalyst, thompsonreuters.com, July 14, 2020). The election is filed on a timely filed partnership return, considering extensions (See “FAQs for Internal Revenue Code (IRC) Sec. 754 Election and Revocation,” IRS.gov.) The election statement must include the name and address of the partnership, and declare it is making the election.
Is There Relief For Filing a Late Election?
“Yes. If the partnership fails to make the election, it can file for late relief under Treasury Regulation Section 301.9100-2, which is an automatic 12-month extension for IRC Section 754 elections. If more than 12 months have passed, late relief can still be requested but must be approved by the Commissioner. See Treasury Regulation Section 301.9100-3.” (See “FAQs for Internal Revenue Code (IRC) Sec. 754 Election and Revocation,” IRS.gov). PLR 202007003, 2/14/20 is an example of the IRS allowing a late election inadvertently left off of the return (See also “A Missed Tax Election: Section 9100 Relief Gives a Second Chance,” Jason Freeman, freemanlaw.com).
The topic of terminating the Section 754 election was getting increased taxpayer interest, such that the IRS was getting more taxpayer requests on terminations. The taxpayer requests rose to the point the IRS originated a new IRS form, Form 15254, “Request for Section 754 Revocation.”
The form came out in 2020 and the latest revision is dated February, 2021. The form is filed at an address in Utah (see form instructions). The IRS sometimes charges a fee for services to taxpayers, but there is no fee to asking for this particular service.
A theme with this topic, should one want to successfully terminate the Section 754 election, is to have an administrative rather than tax-savings motive. The first question on Form 15254 asks if the partnership has done this before. A history of asking for such revocation is considered by the IRS.
The first question can generally be answered negatively, but keep in mind that partnerships may now have a longer history due to the amendment of Section 708. Under current law, partnerships are generally going to be around longer given the amendment to Section 708 with the 2017 Tax Cuts and Jobs Act.
Prior to amendment, the “old partnership” basically terminated and came back as another partnership if 50 percent or more of capital and profits was sold or exchanged within twelve months.
The second question on the form asks if the election will result or is expected to result in an administrative burden. This is detailed as follows:
- Has the nature of the partnership’s business changed, or is it expected to change?
- Has there been a big increase in the partnership assets or the character of those assets?
- Has there been or is there expected to be increased retirements or shifts of partnership interests?
The instructions confirm the form’s goal is to find justifiable administrative reasons for terminating the Section 754. The form instructions go on to say:
“However, no application for revocation of a Section 754 election shall be approved when the purpose of the revocation is primarily to avoid stepping down the basis of partnership assets upon a transfer or distribution. See Regulations Section 1.754-1(c).”
Among the requirements of the cited regulation is that the request be “filed not later than 30 days after the close of the partnership taxable year with respect to which revocation is intended to take effect and shall be signed by any one of the partners.”
The nature of the form confirms the obvious. The IRS isn’t prone to allow revocation of the election just because it becomes taxpayer detrimental. Taxpayers need to plan carefully in the early stages; i.e., think through whether the election is worthwhile, both from the standpoint of tax advantage and increased administrative burden.
There is some prospect in Senator Wyden’s legislative proposals that Section 754 will be modified. For example:
“Wyden’s proposal would require a revaluation when new partners join to ensure that the partnership charges any built-in gain or loss inherent in the partnership’s assets at that time back to the legacy partners….” (“Wyden Proposes Partnership Tax Reform,” Cadwalader, Wickersham & Taft, 9/30/21).
In summary, tax planners should add this topic to the list of elections to periodically reconsider. Keep in mind the file date for revocation is within 30 days after the close of the taxable year rather than the normal return due date.
Mike Pusey, CPA served as National Tax Director at Rojas & Associates. He has a BBA and Master of Science in Accounting from Texas Tech where he graduated with honors. He planned to be an accounting professor and worked a year on the Ph. D. at the University of Arizona before beginning his career at KPMG Peat Marwick, where he worked in...