Published October 3, 2026 · Last updated: October 2026 · Tax Preparation & Planning
The Section 754 Election When One Real Estate Partner Buys Out Another
When a partner sells their interest in a real estate partnership, the incoming partner pays market value but inherits the partnership's old, depreciated basis in the buildings. A Section 754 election fixes that mismatch by stepping up the buyer's share of the property basis to what they actually paid. Without it, the new partner is taxed as if they received depreciation deductions they never got the benefit of.
The election is easy to make and easy to miss, and the consequences of missing it run for as long as the partnership holds the property. This guide explains the mismatch the election exists to fix, why real estate partnerships feel it hardest, who benefits and who decides, what missing it actually costs, the death trigger nobody plans for, and the three statutory sections, §754, §743(b), and §755, that do the work.
- The partnership's basis in its property does not change when an interest changes hands, unless an election is made, or unless an adjustment is mandatory, which it is where the partnership has a substantial built-in loss.
- A Section 754 election allows a basis adjustment so the buying partner's share reflects their purchase price.
- In real estate this usually means real depreciation deductions the new partner would otherwise lose.
- The election binds the partnership going forward, not just for the transaction that prompted it.
- It is the partnership's election, not the partner's, so the buyer has to negotiate for it.
- What we see that most coverage does not say: the buying partner is the one who benefits, and they are often not in the room when the partnership decides whether to make it.
What Mismatch Does the Election Fix?
A partnership has two levels of basis. Each partner has an outside basis in their partnership interest, and the partnership has an inside basis in the assets it owns. When a partner buys an interest from another partner, the buyer's outside basis is what they paid, plus their share of the partnership's liabilities. The partnership's inside basis in the buildings does not move at all.
For a real estate partnership that has held property for fifteen years, that gap is enormous. The property may be worth far more than it cost, and the accumulated depreciation has driven the partnership's basis down. A new partner buys in at today's value and then receives an allocation of depreciation calculated on a basis from another era. The practical effect is that the new partner is under-depreciated and over-taxed: they paid for appreciated property and are depreciating a fraction of what they paid, and when the property is eventually sold they can be allocated gain that economically belongs to the partner who sold out years earlier. A Section 754 election, with the resulting adjustment under Section 743(b), closes the gap for that partner specifically. The partnership's books do not change for everyone; the adjustment is personal to the transferee.
Why Do Real Estate Partnerships Feel It Hardest?
Every partnership can face the mismatch. Real estate partnerships face it worst, for three reasons that compound:
- Depreciation is large and continuous. A commercial building depreciates over thirty-nine years, residential rental over twenty-seven and a half, and the deductions run every year regardless of what the property is worth. Inside basis falls steadily while market value rises.
- Holding periods are long. A partnership formed to buy a Bergen County apartment building in 2005 has twenty years of depreciation behind it. The gap between inside basis and value is not marginal.
- Cost segregation accelerates the divergence. Partnerships that ran a cost segregation study pulled depreciation forward aggressively, which is usually the right decision and which also drives inside basis down faster.
Put those together and a partner buying into an established real estate partnership without a 754 election is buying a materially worse deal than they think.
Buying into or out of a property partnership? The election decision should be made before the transfer, not discovered at the next return, when the leverage to insist on it is gone.
Settle the 754 question before you fund →Who Benefits, and Who Actually Decides?
This is where the practical problem lives, and it is not a tax problem. The partner who gains is the one without the vote; the partners who must agree gain nothing and inherit permanent extra accounting.
| Buying partner | Selling partner | Remaining partners | The partnership | |
|---|---|---|---|---|
| Benefits from the election | Substantially | Not at all | Not at all | No |
| Bears the compliance burden | No | No | Indirectly | Yes, ongoing |
| Has authority to make it | No | No | Usually yes | Makes the election |
| Typical position | Wants it | Indifferent | Reluctant | Reluctant |
Table: who benefits from the Section 754 election, who bears the cost, and who has authority to make it. TC Advisors CPA, September 2026.
This is why the election belongs in the purchase negotiation. A buyer acquiring an interest in a real estate partnership should treat the 754 election as a term of the deal, alongside price, and get it in writing before closing rather than raising it with the accountant afterwards. Our view: a buyer who does not ask for it has usually not been told it exists. The seller has no reason to raise it, and the partnership's accountant works for the partnership.
What Happens If You Miss It?
The election is made on the partnership return for the tax year of the transfer. Miss that window and the elective adjustment is not available for that transfer. One exception runs the other way: where the partnership has a substantial built-in loss, a Section 743(b) adjustment is mandatory even without the election (broadly, where the partnership's inside basis exceeds the value of its property by more than $250,000).
The consequences of a genuine miss are not a one-year problem; they run for the life of the partner's interest. The transferee depreciates a share of an old, low basis for as long as the property is held, and on a building with decades of remaining life that is a long stream of deductions that never arrive. On an eventual sale, the transferee can be allocated gain reflecting appreciation from before they arrived; their outside basis still limits the ultimate economics, but the timing and character effects are unfavorable, because without the adjustment the transferee recognizes income earlier, and potentially of worse character, than their economic position justifies. And the partnership's records now carry a permanent inconsistency between what partners paid and what the books say, which surfaces every time another interest changes hands. Relief for a late election exists in limited circumstances, but it is procedural, discretionary, and not something to rely on.
What About When a Partner Dies?
Buyouts are the transfer everyone expects. Death is the one that catches partnerships unprepared, and it runs on the same rules. When a partner dies, their interest passes to an estate or to heirs, and that is a transfer for these purposes: the successor generally takes a new outside basis in the interest, while the partnership's inside basis in the buildings, again, does not move. So the heirs inherit the same mismatch a purchasing partner would, with one difference that makes it worse, nobody is negotiating. There is no purchase agreement in which to insist on the election, no adviser representing the incoming partner, and often no conversation at all until a return is being prepared months later.
For family-owned real estate partnerships in Bergen County, which are a large share of the property partnerships in this market, this is the most common way the election gets missed. The surviving partners are family members, the accountant prepares the return the way it has always been prepared, and the heirs lose a deduction stream that runs for decades. If a partnership holds appreciated real estate and any partner is over sixty, the 754 question should already be answered in the partnership agreement. Not discussed. Answered, in writing, so it does not depend on somebody raising it during a difficult year.
How Do You Put It in the Partnership Agreement?
The cleanest fix is structural rather than reactive. Partnership agreements can address the election directly, and most older agreements do not. Three provisions do the work:
- A commitment that the partnership will make the election on any transfer, so it is not renegotiated each time under whatever circumstances apply.
- An allocation of the compliance cost, so the partner who benefits bears the incremental accounting cost rather than the partnership absorbing it. This removes the main reason remaining partners resist.
- A requirement that transferees provide the information needed to compute the adjustment, on a timetable that fits the return deadline.
Amending an agreement to add these is inexpensive compared to a single missed election. For partnerships holding appreciated property with an aging partner group, it is one of the higher-value housekeeping items available. And where a partnership operates across state lines, and plenty in this corridor hold property in both New Jersey and New York, the state treatment of the adjustment needs its own look, because federal and state do not automatically move together and a partnership assuming they do can produce two different basis records without noticing.
What Do §754, §743, and §755 Each Do?
The mechanics are worth reading in the statutory language, because each of the three sections does one specific job and people routinely conflate them.
Section 754 is the election itself. If a partnership files the election, the basis of partnership property is adjusted, on a distribution in the manner of section 734 and on a transfer of an interest in the manner of section 743, and the election applies to all distributions and transfers during that year and all subsequent years. Two things deserve attention: the election is made by the partnership, not the incoming partner, which is why a buyer has no unilateral ability to obtain it; and once made it applies to that year and all subsequent years, which is why existing partners sometimes resist, because they are agreeing to an administrative burden that outlives the transaction in front of them.
Section 743(b) is the adjustment on a transfer. Where a 754 election is in effect (or a substantial built-in loss exists), the partnership increases the adjusted basis of partnership property by the excess of the transferee's basis in their interest over their proportionate share of the adjusted basis of partnership property. Critically, the adjustment applies only with respect to the transferee partner. The other partners' positions do not move, which is the point most commonly misunderstood by sellers, who sometimes fear the election will change their own basis.
Section 755 tells you where the adjustment lands. It directs that the increase or decrease be allocated in a manner that reduces the difference between the fair market value and the adjusted basis of partnership properties. That is where the real money is decided in a real estate partnership, and the part nobody negotiates: how much of the adjustment lands on depreciable building rather than on non-depreciable land determines whether the step-up produces annual deductions or only a benefit on a future sale. Two partnerships with identical purchase prices can produce very different outcomes for the buying partner depending on the underlying asset values. Ask how the Section 755 allocation will be performed before you fund, not after the return is filed.
Frequently Asked Questions
Nick Termine, CPA
The partnership does, on its tax return for the year of the transfer. An individual partner cannot make it unilaterally, which is the crux of the whole problem: the partner who benefits from the election, the one buying in, is usually not the one with authority to make it. That is why a buyer acquiring an interest in a real estate partnership should treat the election as a term of the deal, negotiated and put in writing before closing, rather than a question raised with the accountant afterwards. By the time the return is being prepared, the leverage to insist on it is gone.
Stephen Calvo, CPA
Revocation requires IRS approval and is not granted routinely, so you should treat a Section 754 election as effectively permanent when you decide to make it. That permanence cuts both ways. It is the reason the incoming partner gets a reliable, lasting benefit, and it is also the reason existing partners sometimes resist: once the election is in place, it applies to that transfer and to every future transfer and distribution, creating partner-specific recordkeeping the partnership carries indefinitely. That trade-off is real, which is why the cleanest approach is to decide the policy in the partnership agreement rather than deal by deal.
Nick Termine, CPA
No. The selling partner's tax outcome on the sale of their interest is the same whether or not the partnership makes the election, because the Section 743(b) adjustment applies only with respect to the incoming transferee partner, not to anyone else. This is one of the main reasons the election so often goes unmade during a buyout: the seller has no reason to raise it, the remaining partners gain nothing and inherit extra accounting, and the one person who benefits, the buyer, may not even know it exists. Sellers sometimes fear the election will change their own basis. It will not.
Stephen Calvo, CPA
Yes, wherever the LLC is treated as a partnership for tax purposes, which most multi-member LLCs are by default. The label on the entity does not change the analysis at all. A great deal of Bergen County real estate is held in multi-member LLCs precisely because of the liability and flexibility advantages, and every one of those is subject to the same inside-basis-versus-outside-basis mismatch when a member sells or dies. So if you are buying a membership interest in a property-holding LLC, ask the same question you would ask of a partnership: has a Section 754 election been made, and if not, will one be made for this transfer?
Nick Termine, CPA
Yes, and death is the trigger that catches partnerships most unprepared. A transfer on death is a transfer for these purposes: the interest passes to an estate or heirs who generally take a new outside basis, while the partnership's inside basis in the buildings does not move. The heirs inherit the same mismatch a buyer would, but with no purchase negotiation in which to insist on the election and often no conversation until a return is being prepared months later. For family-owned real estate partnerships, this is the single most common way the election gets missed, which is why it belongs in the partnership agreement rather than left to chance.
Stephen Calvo, CPA
Limited procedural relief exists in some circumstances, but it is discretionary, it is not guaranteed, and it should never be the plan. The election is made on the partnership return for the year of the transfer, and the reliable answer is to make the decision before that return is filed. Missing it is not a one-year problem: the incoming partner then depreciates a share of an old, low basis for as long as the property is held, and can be allocated gain on an eventual sale that reflects appreciation from before they arrived. On a building with decades of remaining life, that is a long stream of deductions that never arrives.
Nick Termine, CPA
Then it applies to this transfer automatically and no new election is needed, because a Section 754 election, once made, remains in effect for all subsequent years unless revoked. But confirm it rather than assume it. Partnerships change accountants, and the record of whether a 754 election was ever filed is one of the things most often lost in that handover. If nobody currently working with the partnership can point to the specific return on which the election was filed, treat the question as open and verify it before the next transfer rather than after. An assumed election that turns out never to have been made is an expensive surprise.
Work With TC Advisors
If you are buying into a real estate partnership, ask two questions before you fund: has the partnership already made a Section 754 election, and if not, will it make one for this transfer? Get the answer in the purchase agreement. If you are a partnership facing a transfer, the decision has to be made before that year's return is filed. We handle this as part of our real estate tax work, and you deal directly with a partner. Related reading: real estate syndication waterfalls and promote, cost segregation studies in New Jersey, and depreciation recapture on rental property.
Schedule a consultation →- Cornell Legal Information Institute: IRC §754, manner of electing optional adjustment to basis
- Cornell Legal Information Institute: IRC §743, special rules where a §754 election or substantial built-in loss
- Cornell Legal Information Institute: IRC §755, rules for allocation of basis
- Internal Revenue Service: Publication 541, Partnerships
Related: Real Estate Syndication Waterfalls and Promote, Cost Segregation Studies in New Jersey, and Depreciation Recapture on Rental Property.
