Series 22: Section 754 Election: Step-Up Basis

Section 754 Election: Step-Up Basis

When a partner sells her interest in a partnership, we have seen that inside basis and outside basis can diverge. This will happen with any transfer of interest, including a partner’s retirement or death. The fair market value of the purchased interest becomes the new partner’s outside basis, while her share of the inside basis remains unchanged. The new partner receives a “stepped up” outside basis, while she “steps into the shoes” of the old partner’s share of the inside basis.

This disconnect becomes important when the partnership sells an asset whose value has appreciated. All partners will be allocated the distribution according to their share of the inside basis. The profit from the sale of the asset represents a capital gain allocated to each of the partners.

But the new partner in reality has no capital gain. When the deceased or retired partner sold his interest at fair market value, th