Missed Opportunity When a Partner Dies: the Section 754 Election – Houston Tax Attorneys

There are tax opportunities that come up when someone dies. Many of these relate to those who own real estate in LLCs or partnerships.

One such a opportunity the Section 754 election for partnerships. This is a valuable election–one of the most commonly missed–thatallows the partnership to adjust its inside basis in assets to match the stepped-up basis the heirs receive under Section 1014. That may sound like a topic that only a tax attorney would be interested in, but it is not. The tax savings and impact can be significant.

One might think that missing this election is a permanent mistake, but it’s not. The tax savings can be realized today, even though the partner died years ago.

When filed late, the remedy to fix this error and realize the tax benefits often involves requesting 9100 relief from the IRS. The IRS grants these requests. Private Letter Ruling 202601010 (released January 2, 2026) is an example and it provides an opportunity to consider how a late 754 election can save the heir who inherits the partnership interest on their taxes.

Facts & Background

This ruling involved a partnership that was formed under state law. It filed partnership tax returns. Partner A died. After A’s death, the partnership realized it had failed to make a Section 754 election for the year of A’s death.

The taxpayer filed a private letter ruling to allow for a late election. It did so under Section 301.9100-3 regulations. This regulation allows taxpayers to request extensions of time to make certain elections when they can show they acted reasonably and in good faith, and when granting relief won’t harm the government’s interests.

The partnership submitted its request explaining the inadvertent failure to make the election and to request relief to make a late Section 754 election retroactive back to the year that A died.

This PLR request may sound routine. And it may have been. But the thing that is not stated in the PLR directly is what lead the taxpayer to submit the request.

A more routine and expected reason would be to remedy the mismatch between the A’s heir’s outside basis in the partnership interest and their share of the partnership’s inside basis in its assets. This could come up if the partnership owned appreciated property and later sold it. The heir would be allocated their share of the partnership’s gain based on the partnership’s low historical basis, even though the heir inherited the interest at fair market value and likely paid estate tax on that value. Without the Section 743(b) adjustment that flows from a Section 754 election, A’s heir could have an income tax on appreciation that accrued before they ever owned the partnership interest. That could have been one basis for filing this PLR.

Depreciation and depreciation-related tax savings could have been another reason. We’ll explain the basis mismatch and then focus on the depreciation angle in this article.

Section 754: The Partnership Basis Adjustment Election

Section 754 allows partnerships to elect to adjust the basis of partnership property in two situations. First, when the partnership distributes property to a partner under Section 734(b). Second, when a partnership interest is transferred under Section 743(b). This second category covers transfers by sale, exchange, or death.

Once made, the Section 754 election applies to all distributions and transfers during the taxable year of the election and all subsequent years. The election remains in effect unless the IRS consents to revocation. This permanence means partnerships must consider the long-term implications before making the election.

The election must be made in writing and filed with the partnership return for the taxable year in which the distribution or transfer occurs. Treasury Regulation 1.754-1(b) requires the return to be filed by the due date for that year’s return, including extensions. Missing this deadline means losing the opportunity to make basis adjustments for that year’s transfers, unless the partnership can obtain relief under Section 9100 (there is no automatic adjustment allowed).

How Section 743(b) Adjustments Work When a Partner Dies

Section 743(b) provides the mechanism for adjusting partnership property basis when a partnership interest is transferred. When a partner dies, the heir or estate receives the partnership interest with a basis determined under Section 1014. This basis generally equals the fair market value of the interest on the date of death.

Here’s where the problem arises. The heir now has an “outside basis” in the partnership interest equal to its fair market value at death. But the partnership’s “inside basis” in its assets remains unchanged. The inside basis reflects the partnership’s historical cost in acquiring those assets, which is often far below current fair market value.

Consider a partnership that owns real estate originally purchased for $500,000 but now worth $2 million. Partner A held a 25% interest when he died. His heir receives a stepped-up outside basis of $500,000 (25% of $2 million). But the heir’s share of the partnership’s inside basis is only $125,000 (25% of $500,000).

Without a Section 754 election, this mismatch creates problems. If the partnership sells the real estate, it will recognize $1.5 million in gain. The heir’s share of that gain is $375,000. But the heir just inherited the interest at a $2 million valuation and paid estate tax on that amount. The heir shouldn’t face income tax on appreciation that occurred before the inheritance.

A Section 743(b) adjustment fixes this. With a Section 754 election in place, the partnership increases the inside basis of its assets, but only for the transferee partner. The adjustment equals the difference between the transferee’s outside basis and their share of the partnership’s inside basis. In our example, that’s $375,000 ($500,000 outside basis minus $125,000 share of inside basis).

This adjustment is personal to the transferee. Other partners aren’t affected. When the partnership sells the real estate, the heir’s $375,000 basis adjustment eliminates their share of the gain attributable to pre-death appreciation.

Depreciation Planning When a Partner Dies

The Section 743(b) basis adjustment creates tax planning opportunities beyond simply eliminating gain on future sales. The adjustment can be allocated among different classes of partnership assets, allowing the heir as the transferee to claim accelerated depreciation on shorter-lived property.

Cost segregation studies are often needed for this election. These studies break down real property into components with different recovery periods under the Modified Accelerated Cost Recovery System (“MACRS”). The idea is that a building isn’t just a single 39-year asset. It is made up of 5-year property, like carpet and decorative lighting, 7-year property, like furniture and fixtures, 15-year property, like land improvements and certain building components, and 27.5-year or 39-year property for the building structure itself.

When a partnership owns real estate and a partner dies, the Section 743(b) adjustment gets allocated proportionally across these asset classes based on their relative fair market values. Consider a partnership owning a commercial building. The total Section 743(b) adjustment for the deceased partner’s successor, which was A’s heir in this PLR, is $1 million. A cost segregation study determines that 25% of the building’s value consists of 5-year and 7-year property, 15% is 15-year property, and 60% is 39-year property.

The $1 million adjustment gets allocated accordingly: $250,000 to 5-year and 7-year property, $150,000 to 15-year property, and $600,000 to 39-year property. The heir, A, now has a separate basis in these asset classes attributable to their Section 743(b) adjustment. This separate basis gets depreciated over the applicable recovery periods, generating much faster deductions than if the entire $1 million were treated as 39-year property.

Bonus depreciation makes this even more beneficial. Bonus depreciation allows immediate expensing for property with a recovery period of 20 years or less. Revenue Ruling 2019-13 addressed whether Section 743(b) adjustments qualify for bonus depreciation. The IRS concluded that the portion of a Section 743(b) adjustment allocated to property with a recovery period of 20 years or less qualifies as property placed in service when the transfer occurs.

This ruling can create substantial tax savings. The heir’s Section 743(b) adjustment allocated to short-lived assets can qualify for 100% bonus depreciation, even though the partnership has owned the underlying property for years. Using our earlier example, the $250,000 allocated to 5-year and 7-year property and the $150,000 allocated to 15-year property would qualify for 100% bonus depreciation. The heir could claim $400,000 in immediate deductions in the year of the transfer.

The Section 743(b) Adjustment for Other Partners

The Section 743(b) basis adjustment belongs exclusively to the transferee partner. Other partners don’t receive increased basis in partnership assets when a new partner comes in with a stepped-up basis. The partnership must maintain separate records showing the common inside basis that applies to all partners and the special basis adjustment that applies only to the transferee.

The Section 743(b) adjustment generates additional depreciation for the transferee without reducing other partners’ allocations. The partnership continues claiming its regular depreciation based on common inside basis, allocated normally under Section 704(b). The transferee receives their share of that common depreciation plus separate depreciation from their Section 743(b) adjustment. This additional depreciation is tracked separately and reported to the transferee through supplemental Schedule K-1 disclosures.

Consider a partnership with three equal partners owning a building with $3 million of common inside basis generating $100,000 in annual depreciation. Partner A dies and their heir receives a $2 million Section 743(b) adjustment, with $500,000 allocated to depreciable property generating an additional $50,000 in annual depreciation.

Each continuing partner receives their $33,333 share of the partnership’s $100,000 common depreciation. The heir receives that same $33,333 base allocation plus an additional $50,000 from their Section 743(b) adjustment. The total depreciation across all partners reaches $150,000. The partnership’s Form 1065 reports the $100,000 common depreciation, while the heir’s additional $50,000 gets tracked separately.

The administrative complexity is real. The partnership must track the Section 743(b) adjustment separately, calculate depreciation using appropriate recovery periods, maintain these records throughout the assets’ useful lives, and provide supplemental reporting to the transferee. Software limitations sometimes make this tracking cumbersome, particularly with multiple transferees having different adjustments from transfers at different times.

Partnership agreements sometimes address Section 743(b) adjustments, though not because other partners lose deductions. Agreements might address how to share the administrative costs of tracking these adjustments or how to allocate any economic benefits that flow from the transferee’s improved tax position. Some agreements adjust distributions or profit-sharing ratios to account for tax benefits, but these are business arrangements rather than tax requirements.

The Takeaway

Section 754 elections represent one of the most valuable yet frequently overlooked planning opportunities when a partner dies. The election allows partnerships to adjust inside basis to match the heir’s stepped-up outside basis, eliminating double taxation on pre-death appreciation. The adjustment can be allocated to short-lived assets through cost segregation, creating immediate bonus depreciation deductions that can reach hundreds of thousands of dollars. As this PLR shows, missing the election deadline isn’t necessarily permanent. Partnerships may be granted Section 9100 relief by the IRS when elections are missed, allowing the heirs to preserve substantial tax savings that would otherwise be lost.