Invalid Sec. 754 elections: some observations.

• Author: Brock, Noel P.

Taxpayers often make an election to adjust the basis of partnership property under Sec. 754 whenever a positive basis adjustment would result from such election upon the occurrence of a triggering distribution from a partnership or transfer of a partnership interest. Almost weekly, however, we see IRS letter rulings in which taxpayers are seeking Regs. Sec. 301.9100 relief for a late or missed election. This item discusses the requirements for a valid Sec. 754 election and then highlights some of the reasons for those late or missed elections.

General Requirements for a Valid Sec. 754 Election

No particular form is required for a Sec. 754 election. Regs. Sec. 1.754-l(b) requires that the election be in writing and (1) include the name and address of the partner-ship making the election, (2) be signed by any one of the partners, and (3) contain a declaration that the partnership elects, under Sec. 754, to apply the provisions of Sees. 734(b) and 743(b). To be valid, the Sec. 754 election must be filed with the partnership return for the tax year during which a triggering distribution or transfer occurs. Moreover, the election must be filed no later than the due date of the partnership return, for the year in which the triggering distribution or transfer occurred, as set forth in Regs. Sec. 1.6031-1(e) (including extensions thereof).

Although the above requirements are relatively straightforward, taxpayers continue to encounter difficulty when applying them.

Signed by Any Partner

Many invalid Sec. 754 elections arise because the wrong person signs the election. The regulations make clear that only a partner may sign a valid Sec. 754 election (Regs. Sec. 1.754-1 (b)). It is relatively easy to determine who is a partner in a state law general or limited partnership. But, with the advent of limited liability companies, it has become increasingly more difficult to determine who is and who is not a partner.

For example, is a person who holds a nominal interest in an LLC (that is otherwise classified as a partnership for U.S. federal tax purposes) a partner for purposes of making a valid Sec. 754 election? In certain instances, the IRS has not treated a person as an owner of a domestic eligible entity (and concluded that the entity was a disregarded entity rather than a partnership) where such person did not have economic rights related to the entity (e.g., rights to capital, profits, losses, liquidation proceeds, etc.) and, but for certain limited...