Generally, a partnership cannot adjust the basis of its property because of a distribution of property to a partner or because of a transfer of an
interest in the partnership, whether by sale or exchange or because of the death of a partner. The partnership can adjust the basis only if it files
an election to make an optional adjustment to the basis of its property upon all distributions and transfers. A partnership does not adjust the basis
of partnership property for a contribution of property, including money, to the partnership.
When there is a distribution of partnership property to a partner, the partnership makes the optional adjustment by:
- Increasing the adjusted basis of the retained partnership property by:
- Any gain recognized by the distributee partner on the distribution, plus
- The excess, if any, of the partnership's adjusted basis for the distributed property (immediately before the distribution) over the basis of
the property to the distributee, or
- Decreasing the adjusted basis of the retained partnership property by:
- Any loss recognized by the distributee partner on the distribution, plus
- The excess, if any, of the distributee partner's basis for the distributed property over the partnership's adjusted basis for the property
(immediately before the distribution).
Timing of adjustment.
If a partnership completely liquidates the interest of a partner by making a series of cash payments treated as distributions of the partner's
interest in partnership property, the basis adjustments to partnership property must correspond in timing and amount with the recognition of gain or
loss by the retiring partner, or a deceased partner's successor in interest, with respect to those payments.
Alan owns a one-third interest in the partnership Sylvan Associates. Sylvan has an optional adjustment to basis election in effect. When Alan
retires, Sylvan continues without dissolution and agrees to liquidate Alan's one-third interest in the partnership property by making a series of cash
payments to Alan that are treated as distributions. The total amount of payments Alan will receive is fixed and exceeds the adjusted basis of Alan's
interest in the partnership.
Sylvan increases the adjusted basis of its property by Alan's recognized gain in each partnership tax year during which Alan recognizes gain with
respect to the payments.
When there is a transfer of a partnership interest because of a sale or exchange or a partner's death, the partnership makes the optional
- Increasing the adjusted basis of the partnership property by the excess of:
- The transferee's basis for his or her partnership interest, over
- The transferee's share of the adjusted basis of all partnership property, or
- Decreasing the adjusted basis of partnership property by the excess of:
- The transferee's share of the adjusted basis of all partnership property, over
- The transferee's basis for his or her partnership interest.
These adjustments affect the basis of partnership property for the transferee partner only. They become part of his or her share of the common
Making the election.
The optional adjustment to basis is made by filing a written statement with Form 1065 for the tax year in which the distribution or transfer
occurs. For the election to be valid, the return must be filed on time, including extensions. The statement must include the name and address of the
partnership, be signed by one of the partners, and state that the partnership elects under section 754 to apply sections 734(b) and 743(b) of the
Internal Revenue Code. Once a valid election has been made, it applies in succeeding years until it is revoked.
If the election cannot be made with the return, a partner or the partnership can request an automatic extension of 12 months to make the election.
See section 301.9100-2 of the regulations for more information.
Revoking the election.
Generally, the election can be revoked only with the approval of the IRS. An application to revoke the election must be filed with the IRS director
for your area. This application must be filed within 30 days after the close of the partnership tax year for which the change is to be effective. The
application must be signed by one of the partners and state why the partnership wishes to revoke the election.
Examples of sufficient grounds for approving the application include the following.
- A change in the nature of the business.
- A substantial increase in assets.
- A change in the character of the assets.
- An increased frequency of retirements or shifts of partnership interests.
However, the IRS will not approve an application to revoke the election if its primary purpose is to avoid decreasing the basis of partnership
assets upon a transfer or distribution.