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) TRANSFERS (CONT.)
 When
property is held as community property
and either the husband or wife dies, the
decedent’s (but not the surviving spouse’s) share
of the partnership interest is includable in his
or her gross estate at its value on the applicable
valuation date


Tax basis of both the decedent’s and the spouse’s
interest in the partnership is increased to FMV
If the partnership has a §754 election in effect, the
bases of both spouse’s shares of the partnership
assets will be adjusted
§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.)

Generally, if the basis of a partnership’s recovery
property is increased as a result of the transfer of
a partnership interest, then the increased portion
of the basis is taken into account as if it were
newly-purchased recovery property placed in
service when the transfer occurs and any
applicable recovery period and method may be
used to determine the recovery allowance with
respect to the increased portion of the basis
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
§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