The 754 election

This is the most technical page in the pillar and one of the most valuable, because the 754 election fixes a mismatch that quietly overtaxes new partners and heirs. When someone buys into a partnership or inherits an interest, they pay or are credited with today’s fair market value. But the partnership’s own tax basis in its assets, its inside basis, does not budge to match. That gap is where the money leaks, and a 754 election is the plug.

Inside basis, outside basis, and the gap between them

Two basis numbers live in every partnership. Your outside basis is your tax investment in your partnership interest. The inside basis is the partnership’s tax basis in its actual assets, the buildings. When the partnership is formed and nothing has changed, each partner’s share of inside basis lines up with their outside basis.

They come apart the moment an interest changes hands. Say a partnership owns a building with $1,000,000 of remaining inside basis, now worth $1,800,000. A partner buys another’s 25% interest for $450,000, their share of the current value. The buyer’s outside basis is $450,000, what they paid. But their share of the partnership’s inside basis is still $250,000, a quarter of the old $1,000,000. There is now a $200,000 gap between what they paid and the tax basis the partnership carries on their behalf.

When a partner buys in or inherits, they pay current value, but the partnership’s inside basis stays at its old figure, opening a gap that a 754 election exists to close.

What the election actually does

Without a 754 election, that gap bites later. When the partnership eventually sells the building for $1,800,000, it recognizes $800,000 of gain, and the new partner is allocated their 25% share, $200,000, and taxed on it, even though they already paid full value for their interest. They are taxed on appreciation they bought, not appreciation they earned.

A 754 election lets the partnership make a 743(b) adjustment: a basis step-up specific to that one incoming partner, equal to the gap. Now the new partner’s share of inside basis matches what they paid. When the building sells, their allocated gain drops to zero, while the other partners, who genuinely benefit from the sale, recognize theirs. The election aligns tax reality with economic reality. It also gives the incoming partner extra depreciation on the stepped-up portion in the meantime.

A single 754 election covers two mechanisms: 743(b), the partner-specific adjustment when an interest transfers, and 734(b), a partnership-wide adjustment triggered by certain distributions. You do not elect them separately.

A 754 election creates a basis step-up for the incoming partner alone, so they are not taxed on appreciation they already paid for.

The estate-planning trap almost nobody mentions

Here is the seam that reaches beyond partnership mechanics into estate planning, and it is the one that costs families real money. When a partner dies, Section 1014 gives their heirs a stepped-up basis to fair market value. But that step-up applies only to the outside basis, the interest itself. It does not touch the partnership’s inside basis in the buildings.

So without a 754 election, the heirs inherit an interest stepped up to today’s value, yet the partnership still carries the decedent’s old inside basis. When the partnership later sells appreciated property, the heirs are allocated and taxed on gain that includes the very appreciation their outside basis was already stepped up for. They pay tax twice on the same increase in value. A 754 election with a 743(b) adjustment closes that gap and lets the inside basis step up to match, giving the heirs the higher depreciation and the smaller gain they should have. This is why the election belongs in estate planning for any partnership holding appreciated real estate, and it connects directly to the trusts and LLCs discussion of basis step-up at death.

The step-up at death applies only to the partnership interest, not the buildings inside it, so without a 754 election heirs can be taxed twice on the same appreciation.

The catch: it is forever

The reason partnerships do not make the election reflexively is that it is, for practical purposes, irrevocable. Once in place, it forces a 743(b) or 734(b) computation on every future transfer and certain distributions, each requiring an asset-by-asset allocation under Section 755. For a partnership with frequent transfers, that is permanent recordkeeping. The election is worth it when the partnership holds appreciated assets, transfers are foreseeable, or estate planning is in view, and less attractive for a small, low-appreciation partnership near wind-down.

The bottom line

• Buying into or inheriting a partnership creates a gap between what you paid and the partnership’s inside basis.
• Without a 754 election, that gap taxes the new partner or heir on appreciation they already paid for.
• A 754 election makes a partner-specific 743(b) step-up that closes the gap and adds depreciation.
• At death, the step-up reaches only the interest, not the assets, so a 754 election prevents double taxation of heirs.
• The election is effectively irrevocable and creates permanent recordkeeping, so it is a deliberate choice.

For the basis system this adjusts, read partnership taxation basics. For the step-up at death it protects, see trusts and LLCs. For the full picture, start at the entity and LLC tax strategies hub.

Last verified August 2026.