Section 754 election and 743(b) basis adjustments

“Once an election is made under section 754, it applies both to all distributions and to all transfers made during the tax year and in all subsequent tax years unless the election is revoked.” IRS, Instructions for Form 1065 (2025)

What does a section 754 election do?

A section 754 election lets a partnership adjust the inside basis of its property to reflect what happened at the partner level when an interest changes hands or property is distributed. Without the election, IRC sections 743(a) and 734(a) leave inside basis unchanged, unless one of the mandatory loss rules applies. Treas. Reg. 1.754-1(a) does not allow a partnership to elect section 743(b) or 734(b) alone: one election covers both. It applies to every distribution and every transfer in the year of the election and in all later years until it is revoked.

The effect is mostly timing. A buyer who pays more than its share of inside basis gets a section 743(b) step-up that produces extra depreciation or a smaller gain when the partnership sells the asset, and the step-up belongs to that buyer only. The same election also forces step-downs on later transfers and distributions where the numbers run the other way, which is why the decision affects every partner.

How do you make a section 754 election?

Treas. Reg. 1.754-1(b)(1) requires a written statement filed with the partnership return for the tax year in which the distribution or transfer occurs, and the return must be filed by its due date, including extensions. The statement must set out the name and address of the partnership and declare that the partnership elects under section 754 to apply the provisions of section 734(b) and section 743(b). Once a valid election is in place, the partnership doesn't file a new one in later years.

A missed election can usually be fixed with the automatic 12-month extension in Treas. Reg. 301.9100-2, if corrective action is taken within 12 months of the original deadline, according to the 2025 Instructions for Form 1065. A revocation request goes on Form 15254, Request for Section 754 Revocation.

How do section 743(b) and 734(b) adjustments work?

A section 743(b) adjustment applies when an interest is transferred by sale or exchange or on a partner's death. Under Treas. Reg. 1.743-1(b), the partnership increases inside basis by the excess of the transferee's outside basis over the transferee's share of inside basis, or decreases it by the reverse, and the adjustment belongs to the transferee only. Treas. Reg. 1.743-1(d) measures that share as previously taxed capital plus the share of partnership liabilities, using a hypothetical sale of every asset for fair market value immediately after the transfer.

A section 734(b) adjustment applies to distributions and changes the common basis of the property the partnership keeps. IRC section 734(b) increases inside basis by gain the distributee recognizes under section 731(a)(1) and by basis lost when section 732(a)(2) or (b) limits the distributee's basis in distributed property. It decreases inside basis by loss recognized under section 731(a)(2) and by basis created under section 732(b). Section 755 allocates both adjustments among the assets. The Form 7217 page shows the distributee's side.

When is a basis adjustment mandatory without a section 754 election?

IRC sections 743(a) and 734(a) require two loss adjustments even without a section 754 election. A transfer of an interest forces a section 743(b) step-down when the partnership has a substantial built-in loss immediately after the transfer. Under section 743(d)(1), that means the partnership's adjusted basis in its property exceeds the property's fair market value by more than $250,000, or the transferee would be allocated a loss of more than $250,000 if the partnership sold all its assets for fair market value immediately after the transfer.

A distribution forces a section 734(b) step-down when there is a substantial basis reduction. Section 734(d) adds the distributee's loss recognized on a liquidating distribution to the excess of the distributee's basis in distributed property over the partnership's basis in it, and the rule applies when that sum exceeds $250,000. The partnership reports mandatory adjustments on Schedule B question 10d, with the aggregate amount as a positive number. The test applies to every transfer and distribution.

What does a section 743(b) calculation look like?

For example, partnership PRS has three equal partners and a section 754 election in effect. Partner A sells her one-third interest to T for $90,000 cash. PRS holds $30,000 of cash, inventory with a $45,000 basis and a $60,000 value, and a building with a $120,000 basis and a $210,000 value. PRS owes $30,000 of liabilities, shared equally, and the building carries no depreciation recapture. Under Treas. Reg. 1.755-1(b), the adjustment is split between ordinary income property and capital gain property in line with T's share of the hypothetical gain in each class.

The $35,000 step-up belongs to T alone. PRS reports it as the aggregate positive amount on Schedule B question 10b, attaches the statement Treas. Reg. 1.743-1(k)(1) requires, and reports T's extra cost recovery on the building on a statement for Schedule K, line 20c, code U.

What do reviewers check on a section 754 election?

A reviewer checking a section 754 election confirms six items, each tied to the regulations or the 2025 Form 1065. The first document to pull is the election statement itself, from the return for the year the election was first made, because Schedule B question 10a only asks for the effective date.

For each transfer during the year, the reviewer also needs the buyer's written notice, the purchase price, the K-1 item K1 liability share and the fair market values the partnership used in the hypothetical sale. For each distribution, the reviewer needs the distributee's basis results from Form 7217 and the partnership's basis in the distributed property. Those documents are the only way to test the mandatory loss rules, because a substantial built-in loss can exist in a partnership that never made the election.