Making a Valid Sec. 754 Election Following a Transfer of a Partnership Interest
Editor: Kevin D. Anderson, CPA, J.D.
Partners & Partnerships
To adjust the basis of partnership property upon the transfer of an interest under Sec. 743(b) or to adjust the basis of partnership property following a distribution under Sec. 734(b), a taxpayer must generally make a Sec. 754 election. Although making the election seems simple, it is not uncommon for a partnership to attempt to make a valid Sec. 754 election, only to find that it inadvertently failed to satisfy all of the regulatory requirements. Where a partnership failed to properly make the Sec. 754 election, limited recourse may be available to pursue corrective action.
Regs. Sec. 1.754-1(b)(1) provides that an election under Sec. 754 to adjust the basis of partnership property under Secs. 734(b) and 743(b) shall be made in a written statement filed with the partnership return for the tax year during which the distribution or transfer occurs. For the election to be valid, the return must be filed no later than the time prescribed for filing the return (including extensions) for the tax year. Further, a valid Sec. 754 election must (1) set forth the name and address of the partnership 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 Secs. 734(b) and 743(b).
IRS Publication 4163, Modernized e-File (MeF) Information for Authorized IRS e-file Providers for Business Returns (rev. December 2014), which provides guidance to taxpayers on including forms and elections that require signatures when e-filing a tax return, indicates that, where a taxpayer is making an election that requires a signature, a signed election may be attached to the e-filed return in a PDF. It is worth noting that IRS Counsel reviewed regulations to identify forms and elections that require a separate signature to determine whether the signature requirements could be changed. T.D. 9300 and T.D. 9329 contain amendments to the income tax regulations and the procedure and administration regulations. While these regulations eliminate certain third-party signature requirements considered to have been impediments to the electronic submission of tax returns and other forms, no changes appear to have been made to the Sec. 754 election requirements, including the requirement that the election contain a partner’s signature.
Automatic Relief for Failure to Timely Elect Under Sec. 754
If the taxpayer fails to timely file a valid Sec. 754 election, automatic relief may be available under Regs. Sec. 301.9100-2. Under this regulation, a taxpayer is granted an automatic extension of 12 months from the due date for making certain regulatory elections. To obtain relief under these provisions, the regulation mandates that the taxpayer take the steps required to correctly file the election in accordance with the statute or the applicable regulation. Required steps include filing an original or amended return for the year in which the taxpayer intended the election to be effective. This original or amended return must include the correctly completed Sec. 754 election.
Any return, statement of election, or other form of filing made to obtain an automatic extension must provide the following statement at the top of the document: “FILED PURSUANT TO §301.9100-2.” Further, any filing made to obtain an automatic extension must be sent to the same address that would have applied had the filing been timely made. An automatic extension does not require a private letter ruling, which means user fees do not apply to taxpayers taking corrective action.
The regulations also provide that taxpayers making an election under an automatic extension (and all taxpayers whose tax liability would be affected by the election) must file their return(s) in a manner that is consistent with the election and must comply with all other requirements for making the election for the year the election should have been made and for all affected years; otherwise, the IRS may invalidate the election.
Other Relief for Failure to Make a Timely Election Under Sec. 754
If the taxpayer fails to timely file a valid Sec. 754 election and automatic relief under Regs. Sec. 301.9100-2 is not available, the only recourse may be to seek relief under Regs. Sec. 301.9100-3.
Under Regs. Sec. 301.9100-3(a), requests for relief will generally be granted if the taxpayer provides evidence that establishes the taxpayer acted reasonably and in good faith and that granting the extension will not prejudice the government’s interests.
A taxpayer will be deemed to have acted reasonably and in good faith with respect to the requested extension if the taxpayer (1) requests relief before the IRS discovers the failure to make the election; (2) failed to make the election because of intervening events beyond the taxpayer’s control; (3) failed to make the election because, after exercising reasonable diligence (taking into account the taxpayer’s experience and the complexity of the return or issue), the taxpayer was unaware of the necessity for the election; (4) reasonably relied on the IRS’s written advice; or (5) reasonably relied on a qualified tax professional (including an employee), and the tax professional failed to make, or advise the taxpayer to make, the election.
A taxpayer will not be considered to have reasonably relied on a qualified tax professional if the taxpayer knew, or should have known, that (1) the professional was not competent to render advice on the regulatory election, or (2) the professional was not aware of all relevant facts.
Further, a taxpayer will be deemed not to have acted reasonably and in good faith with regard to a requested extension if the taxpayer (1) seeks to alter a return position for which an accuracy-related penalty has been or could be imposed at the time the taxpayer requests relief (taking into account any qualified amended return filed), and the new position requires or permits a regulatory election for which relief is requested; (2) was informed in all material respects of the required election and related tax consequences but chose not to file the election; or (3) uses hindsight in requesting relief.
To pursue relief under Regs. Sec. 301.9100-3, very specific factual and procedural requirements must be satisfied. In addition, because obtaining this relief requires requesting a private letter ruling, substantial user fees apply ($9,800 for most taxpayers under the current schedule).
The regulations provide that to obtain this discretionary extension, the taxpayer must submit a detailed sworn affidavit (1) describing the events that led to the failure to make a valid election and to the discovery of the failure; (2) indicating the existence of grounds for the extension, along with sworn affidavits by others that support these grounds; and (3) stating whether the taxpayer’s return or returns for the tax year(s) in which the election should have been made (or any tax year(s) that would have been affected by the election had it been timely made) are either being examined by the IRS or being considered by an appeals office or a federal court. In appropriate cases, similar affidavits may be required of the taxpayer’s tax return preparer, any individual who made a substantial contribution to the preparation of the return, and any tax professional who advised the taxpayer about the election.
Additionally, the taxpayer must submit a copy of any documents that refer to the election and, when requested, must submit a copy of the taxpayer’s return for any tax year for which the taxpayer requests an extension of time to make the election (and any return affected by the election), along with a copy of the returns of any other taxpayers affected by the election.
Tax Return Filing and Notification Requirements Upon a Transfer of Partnership Interest
In the event of a transfer of a partnership interest giving rise to a basis adjustment under Sec. 743, the partnership must attach a statement to the partnership return for the year of the transfer that provides the name and taxpayer identification number (TIN) of the transferee partner and the computation and allocation of the basis adjustment (Regs. Sec. 1.743-1(k)(1)). The computation of the basis adjustment is generally determined per the formula in the exhibit below.
A transferee partner acquiring an interest by sale or exchange is required to notify the partnership in writing within 30 days of the transfer. The written notice must contain the name, address, and TIN of the transferee, and, if known, the transferor; the date of the transfer; the amount of any liabilities assumed or taken subject to by the transferee; and the amount of any money and the fair market value (FMV) of any other property delivered or to be delivered for the partnership interest. In addition, the written notice to the partnership must be signed under penalties of perjury (Regs. Sec. 1.743-1(k)(2)(i)).
For a transfer upon death, the transferee partner must notify the partnership, in writing, within one year from the date of the transferor’s death. The written notice must be signed under penalties of perjury and must include the names, addresses, and TINs of both the deceased and the transferee partner; the date on which the transferee became the owner of the partnership interest; the FMV of the partnership interest on the applicable valuation date; and the method used to determine FMV (Regs. Sec. 1.743-1(k)(2)(ii)).
The partnership may rely on this written notice to determine the transferee partner’s basis adjustments unless the tax matters partner or any partner who has responsibility for the partnership’s federal income tax reporting has information that indicates that the statement is clearly erroneous. The partnership is not required to make the adjustment until it has received written notice. However, the partnership is treated as having received written notice if the tax matters partner or another partner who has responsibility for the partnership’s federal income tax reporting knows that there has been a transfer (Regs. Secs. 1.743-1(k)(3) and (4)).
If the transferee partner does not comply by providing written notice, the partnership must attach a statement to its return when it is otherwise notified. The statement must set forth the name and TIN, if known, of the transferee. In addition, on the first page of the partnership’s return and on the first page of any schedule or information statement relating to the transferee partner’s share of income, deductions, credits, etc., the following caption must prominently appear: “RETURN FILED PURSUANT TO §1.743-1(k)(5).”
In this fashion, the partnership can report the transferee partner’s share of partnership items, without any adjustment being made for the transferee partner’s benefit. After written notice is received, the partnership must make the applicable adjustments to the basis of the partnership property, as of the date of transfer, in any amended return otherwise to be filed by the partnership or in the next regularly filed return. At that time, the partnership must provide sufficient information for the transferee partner to file amended returns to properly reflect the Sec. 743 adjustment (Regs. Sec. 1.743-1(k)(5)).
Adherence to this regulation is especially important in merger-and-acquisition transactions when practitioners that represent the sellers are engaged to prepare only the final return of a technically terminated partnership (i.e., when a sale of 50% or more of the partnership interests occurs within 12 months under Sec. 708(b)(1)(B)), as practitioners may neither be able to amend the final return post-sale nor have been engaged to prepare the initial return of a technically terminated partnership. This, of course, creates another area of potential exposure for which corrective action may not be easily available.
Conclusion
A valid election under Sec. 754 could substantially benefit the owners of entities treated as partnerships for tax purposes (i.e., general partnerships, limited partnerships, limited liability companies, limited liability partnerships, and other multimember entities for which a check-the-box election was made to treat the entity as a partnership for tax purposes, or for which the default classification in the absence of an election is to treat the entity as a partnership) because it allows a partnership to “step up” the basis of the assets within the partnership. Where the step-up is deemed to be related to depreciable or amortizable property, depreciation and amortization deductions are generally allowed in the year of the election.
Failure to properly execute tax return elections is a major area of litigation for practitioners. The advent of tax return e-filing technology has complicated the process and has presented procedural challenges for executing elections that require a partner’s signature. Therefore, it is crucial for taxpayers and practitioners alike to have a strong knowledge of the regulatory requirements for making a valid Sec. 754 election. It is equally important to understand existing relief procedures that may allow for corrective action in the event that any procedural requirements were inadvertently not met. The authors recommend extreme caution when making elections, especially elections requiring signatures, and urge practitioners not to leave anything to chance.
EditorNotes
Kevin Anderson is a partner, National Tax Office, with BDO USA LLP in Bethesda, Md.
For additional information about these items, contact Mr. Anderson at 301-634-0222 or kdanderson@bdo.com.
Unless otherwise noted, contributors are members of or associated with BDO USA LLP.
