Chapter 13 Basis Adjustments
to Partnership Property
Basis Adjustment to
Partnership Property - §743(b)
 Under the general entity approach of §743(a), the
price paid by the purchasing partner affects only
the partner’s adjusted basis in his or her
partnership interest, not the basis of his or her
share of the partnership assets
 Under §743(b), if the partnership makes a §754
election in the year of sale or has a substantial
built-in loss immediately after the transfer, the
transfer of a partnership interest will trigger a
required adjustment to the basis of partnership
assets
§743(b) Transfers
 §743(b) applies to any transfer of partnership
interests considered a sale or exchange

It does not apply to the gift of a partnership interest, nor to
the contribution of cash or property to a partnership in
exchange for an interest in that partnership
§743(b) Adjustments-Overview
 The amount of the §743(b) adjustment to all the
partnership properties is the difference between the
incoming partner’s basis for his or her partnership
interest and that partner’s share of the adjusted basis
of the partnership property at the time of purchase
§743(b) Adjustments-Overview (Cont.)
 If the purchasing partner’s initial adjusted basis in
the partnership interest is greater than his or her
share of the adjusted basis of partnership assets, the
total basis adjustment to the partnership assets is
upward in an amount equal to the excess. And vice
versa.

The total adjustment is then allocated among the partnership
properties in accordance with § 755
Partnership with Substantial
Built-in Loss
 Basis adjustments under Code Sec. 743(b) are
triggered by the transfer of a partnership interest if
the partnership has a “substantial built-in loss”
 A partnership has a substantial built-in loss if the
adjusted basis of partnership property exceeds its
FMV by more than $250,000

In such cases, the partnership is required to adjust its basis in
its assets under §743(b) even if no §754 election has been
made
Partnerships Without Substantial Built-in Losses
 If the partnership does not have a substantial built-
in loss, no basis adjustment is required or allowed
unless the partnership has a §754 election in effect or
chooses to make one effective for the year of the
transfer
Making the §754 election
 The election is made by attaching a statement
declaring a §754 election to the partnership’s
“timely” (filed by due date, including extensions)
Form 1065. The statement should include the
partnership’s name, address and TIN and be
signed by any partner.
 The election applies to all sales, exchanges,
transfers upon death, and the four distribution
situations under §734(b), until the election is
terminated
Making the §754 election (Cont.)
 An application for revocation of a §754 election must
be filed no later than 30 days after the close of the
partnership’s taxable year with respect to which the
election is intended to take effect
Making the §754 election (Cont.)
 Acceptable reasons for revocation include:
 A change in the nature of partnership trade or business.
 A substantial increase in assets.
 A change in the nature of assets.
 An increasing administrative burden.
Calculating the §743(b) Adjustment
 The total basis adjustment is the difference between
the incoming partner’s basis in the partnership
interest and their share of the adjusted basis of
partnership property
 In general, this difference is the same as the gain or
loss the selling partner would have recognized if the
partnership had sold all of its assets for their FMV
Allocating the §743(b) Adjustment
 The total §743(b) basis adjustment is allocated first
between two classes of property :


Capital gain property and
Ordinary income property
 The basis adjustment allocated to each class is then
allocated among the items within each class
Allocating the §743(b)
Adjustment (Cont.)
 The portion of the basis adjustment allocated to
ordinary income property would be equal to the total
income, gain and loss that would be allocated to the
transferee upon the sale of the partnership’s ordinary
income property if the partnership sold all its assets
in a fully taxable transaction
Allocating the §743(b)
Adjustment (Cont.)
 The basis adjustment to capital gain property is
equal to the total adjustment less the amount
allocated to ordinary income property
 If the basis adjustment to capital gain property is a
decrease, it cannot exceed the partnership’s basis in
capital gain property.
 Any excess is applied to reduce the basis of ordinary
income property
Allocating the §743(b)
Adjustment (Cont.)
 Within the class of ordinary income property, the
basis of the purchaser’s share of each property is
therefore generally equal to its FMV
 However, this basis adjustment to FMV may be
reduced by negative adjustments to capital gain
property exceeding the basis of the capital gain
property
Allocating the §743(b)
Adjustment (Cont.)
 The amount of the basis adjustment to each item of capital
gain property is equal to:
 1. The amount of income, gain, or loss allocated to the
transferee from the hypothetical sale of the item; reduced
(increased) by
 2. The product of:
Total remaining unallocated gain or loss and
 (FMV of the item of property)/(FMV of all of the partnership’s
items of capital gain property)

§743(b) Adjustment Made for
Benefit of Transferee
 The basis adjustment constitutes an adjustment to
the basis of partnership property with respect to the
transferee only
 For purposes of calculating income, deduction, gain,
and loss, the transferee will have a special basis for
those partnership properties, the bases of which are
adjusted under §743(b).
§743(b) Adjustment Made for
Benefit of Transferee (Cont.)
 The partnership first computes its partnership items
of income, deduction, gain or loss at the partnership
level


It then allocates these items among the partners, including the
transferee, and adjusts the partners’ capital accounts
accordingly.
The partnership then adjusts the transferee’s distributive share
of the items of partnership income, deduction, gain, or loss to
reflect the effects of the transferee’s basis adjustment
§743(b) Adjustment Made for Benefit of
Transferee (Cont.)
 The amount of any negative basis adjustment
allocated to depreciable property first decreases the
transferee’s distributive share of the partnership’s
depreciation deductions from that property

Then, if necessary, decreases the transferee’s distributive share
of the partnership’s depreciation deductions from other
property
Distribution of Property with §743(b)
Adjustments
 The §743(b) adjustment will continue to affect only
the same partner


If the property subject to basis adjustment is distributed to the
partner for whom the basis adjustment was made, that
partner’s basis will take into account the basis adjustment
If the property is distributed to other partner(s), the special
basis adjustment is shifted to property of like kind still
remaining in the partnership
Distribution of Property with
§743(b) Adjustments (Cont.)
 When the interest of a partner to whom a basis
adjustment is in effect is completely liquidated, the
partner’s entire remaining adjustments in all
partnership property must be allocated to the
distributed property
 The partner will have a total adjusted basis in the
distributed property equal to the adjusted basis of
his or her partnership interest
Transfer of Partnership Interests with
§743(b) Adjustments
 Transfers by sale: A new partner who acquires a
partnership interest from an outgoing partner, in
respect of whom a §743(b) adjustment was in effect,
does not succeed to the selling partner’s basis
adjustment

With a §754 election, a new basis adjustment is calculated
Partner-Level §743(b)
Adjustments – §732(d)
 A transferee partner, to whom a distribution of
partnership property (other than money) is made
within two years of the date the transferee partner
acquired his or her partnership interest, can make an
election to treat the adjusted basis of the distributed
partnership property as if a §743(b) adjustment were
in effect with respect to the partnership property
Technical Terminations
 The transfer of a partnership interest can have a
significant tax impact on the continuing partners if
the transfer causes the “termination” of the
partnership

A termination occurs only when 50 percent or more of the total
interest in the partnership’s capital and profits is sold or
exchanged within a 12-month period
Technical Terminations (Cont.)
 The term “sale or exchange includes:
 1. Sales violating an anti-assignment agreement
 2. Taxable and tax-free exchanges
 3. The distribution of a partnership interest from a partnership
or a corporation
 4. The contribution of a partnership interest to a corporation
Technical Terminations (Cont.)
 The term “sale or exchange includes:
 5. The contribution of a partnership interest to another
partnership
 6. Abandonment of a partnership interest when the partner is
relieved of a share of partnership debt under §752(b) in excess
of his or her basis in his or her interest; and
 7. The sale of a partnership interest to new or existing partners
Technical Terminations (Cont.)
 The term “sale or exchange” does not include:
 1. Bequests and inheritances
 2. Gifts when the donor has no debt relief. Debt relief suggests
a part gift/part sale analysis; and
 3. Entry of a new partner
Consequences of Partnership Termination
 The following is deemed to occur upon the
termination of partnership:


The partnership contributes all of its assets and liabilities to a
new partnership in exchange for an interest in the new
partnership; and
Immediately thereafter, the terminated partnership
liquidates, distributing interests in the new partnership to the
purchasing partner and the other remaining partners in
proportion to their respective interests in the terminated
partnership
Basis Adjustments Upon Distributions of
Property - §734(b)
 When a distribution results in a “substantial” basis
reduction, the partnership is required to adjust its
basis in remaining partnership properties under
§734(b) regardless of whether the partnership makes
a §754 election or not
Basis Adjustments Upon Distributions
of Property - §734(b) (Cont.)
 A “substantial basis reduction” exists when the sum
of the two items below exceeds $250,000 :


The amount of loss recognized by the distributee partner on
receipt of the distribution; and
The step-up in basis of distributed property in the distributee
partner’s hands
No §754 Election in Effect
 Generally, unless the partnership has a §754 election,
the distribution of property or cash are nontaxable
events for the partnership
 However, the partnership may be required to
recognize gain or adjust the basis of its assets if the
distribution triggers the disproportionate
distribution or the deemed sale rules
§754 Election in Effect or Substantial Basis
Reduction
 Generally, the basis of retained partnership property
will not be adjusted upon a distribution to partner(s)
under §734(a)
 However, if the partnership makes a §754 election or
there is a substantial basis reduction, a §734(b) basis
adjustment will be made to the retained partnership
property
§754 Election in Effect or Substantial Basis
Reduction (Cont.)
 The adjustment process has two steps:
 Computing the total adjustment, and
 Allocating the total adjustment to the partnership assets
Amount of the §734(b) Adjustment
 If a distribution of money is greater than the
partner’s outside basis, the partnership will increase
the adjusted basis of its assets by the amount of gain
recognized by the distributee partner
 If a distribution to a partner consists solely of money,
unrealized receivables, and/or inventory in complete
liquidation of his or her partnership interest and the
distributee partner recognizes a loss, the partnership
will reduce the adjusted basis of its undistributed
assets by the amount of the loss
Amount of the §734(b)
Adjustment (Cont.)
 In a distribution of property in which the partner
takes a lower basis in the property than the
partnership had, the partnership will increase its
basis in remaining properties by a like amount
 If upon complete liquidation of a partner’s interest
the total adjusted basis of the assets in the
distributee partner’s hands is greater than it was in
the hands of the partnership, the partnership must
decrease the adjusted basis of retained partnership
property by the amount of this difference
Amount of the §734(b)
Adjustment (Cont.)
 §734(b) basis adjustment is made for the benefit of
all remaining partners and allows the partners to
avoid any distortion in reporting their future shares
of partnership taxable income
Allocation of §734(b)
Adjustment (Cont.)
 The allocation rules first apportion the total §734(b)
adjustment between:


ordinary income property and
§1221/1231 “capital gains” property
 Then the amount of the adjustment allocated to each
class is further allocated among the assets within
each class
Allocation of §734(b)
Adjustment (Cont.)
 If a positive or negative §734(b) adjustment arises
when the distributee partner recognizes gain or loss,
respectively, then the upward or downward
adjustment is to be allocated only to “capital gains
assets”
 If the adjustment is caused by the partner’s adjusted
basis in the distributed property being less than or
greater than the partnership’s adjusted basis, then
the increase or decrease is allocated to the
partnership assets that are of a character similar to
that of the distributed property
Allocation of Adjustment Among
Property within a Class
 If there is an increase in basis to be allocated to a
group of properties within a class, the increase must
be allocated first to properties with unrealized
appreciation in proportion to their respective
amounts of unrealized appreciation before such
increase

Any remaining increase must be allocated among the
properties within the class in proportion to their FMV
Allocation of Adjustment Among Property
within a Class (Cont.)
 If there is a decrease in basis to be allocated to a
group of properties within a class, the decrease must
be allocated first to properties with unrealized
depreciation in proportion to their respective
amounts of unrealized depreciation before such
decrease

Any remaining decrease must be allocated among the
properties within the class in proportion to their adjusted
bases
Substantial Basis Reduction
 §734(a) requires the partnership to adjust its
basis in remaining assets following a
distribution that results in a “substantial basis
reduction” regardless of whether a §754
election is made or not
 The partnership is required to decrease its tax
basis in its remaining properties in order to
ensure that remaining partners are not allowed
to artificially inflate their shares of subsequent
partnership losses