Partnership Basis Step-Ups & Step-Downs: IRC §§743, 734, and 754
Partnerships (including most multi-member LLCs) can “adjust basis” of partnership property to reflect a partner-level purchase price or the economics of distributions. When used correctly, these adjustments align depreciation/amortization and future gain or loss with the real dollars at stake. The rules live in three code sections that work together:
- §743(b) — partner-specific basis adjustments after a transfer of an interest (sale or death).
- §734(b) — entity-level basis adjustments after certain distributions (including liquidations).
- §754 — the election a partnership makes to turn on §743(b) and §734(b) in the year of the triggering event.
§743(b): Step-Ups/Downs After a Transfer (Sale or Death)
When a partner buys an interest (or inherits one), their outside basis usually differs from their share of the partnership’s inside basis. With a timely §754 election in effect, the partnership computes a §743(b) adjustment for the transferee partner only. This adjusts the inside basis of the partnership’s assets as to that partner, producing a step-up or step-down and changing that partner’s depreciation, amortization, and gain/loss on disposition.
- Triggered by: sale or exchange of an interest; death of a partner.
- Allocation among assets follows §755 (to capital/§1231/ordinary classes and then by built-in gain/loss).
- Only the transferee’s share of inside basis is adjusted; other partners are unaffected.
§734(b): Step-Ups/Downs After Distributions
After certain distributions, the partnership’s inside basis can diverge from partner economics. If a §754 election is in effect (or a mandatory adjustment applies), the entity makes a §734(b) adjustment to increase or decrease the basis of remaining partnership property. This keeps future income, deductions, and gain/loss aligned for the continuing partners.
- Triggered by: liquidating distributions or non-liquidating distributions that create a basis “mismatch.”
- Adjustment applies at the entity level—affects all partners prospectively.
- Allocated among assets under §755.
§754 Election: How and When
The §754 election is made by the partnership via a statement attached to a timely filed return (including extensions) for the year of the triggering event (transfer or distribution). Once made, it stays in effect for all subsequent years unless revoked with IRS consent.
- Missed it? Consider relief for late regulatory elections if facts support it.
- Some adjustments can be mandatory even without a §754 election (e.g., substantial built-in loss under §743(d)), but planning flexibility is far better with a valid §754 on file.
Practical Effects (Step-Up vs Step-Down)
- Step-Up: Higher depreciable/amortizable basis for the transferee under §743(b), or higher entity basis under §734(b) after distributions; often reduces future taxable income.
- Step-Down: The reverse—less depreciation and potentially more gain later.
- Capital accounts: §743(b) is a partner-specific inside basis layer and typically does not change capital accounts; §734(b) is an entity inside basis change and doesn’t change capital accounts either, but it affects future allocations.
- Asset sales: §743(b)/§734(b) alter gain recognition by asset class when the partnership sells property.
When You Can Use It (and When to Call a Pro)
- Use §743(b) (with §754 on) when an interest is purchased or inherited and you want the buyer/heir’s deductions and gain/loss to reflect their purchase price/stepped-up basis.
- Use §734(b) (with §754 on) when distributions—especially liquidations—create basis mismatches you want corrected at the entity level.
- Call a professional when there is: significant built-in gain/loss, hot assets (§751), complex waterfalls, tiered partnerships, real estate with cost seg layers, or you missed a §754 election deadline.
- Model before you file: §755 allocation details can materially change depreciation, §1231/§1245/§1250 outcomes, and exit taxes.
Code Pointers
- §743(b) — Basis adjustment to transferee partner after transfer of an interest.
- §734(b) — Basis adjustment to partnership property after certain distributions.
- §754 — Election by partnership to apply §§743(b) and 734(b).
- §755 — Allocation of basis adjustments among partnership assets.
- §743(d) — Substantial built-in loss rules (can require mandatory adjustments).