Editor: Greg A. Fairbanks, J.D., LL.M.
In September 2020, the IRS released a draft of a new form, Form 15254, Request for Section 754 Revocation, that a partnership would use to request a revocation of a Sec. 754 election. The IRS explained that the form has been developed due to an increase in Sec. 754 election revocation applications since the technical termination of a partnership under former Sec. 708(b)(1)(B) was repealed under the law known as the Tax Cuts and Jobs Act (TCJA), P.L. 115-97 (see 85 Fed. Reg. 55,936 (Sept. 10, 2020)).
Though no specific data is available to the public about how many Sec. 754 revocation applications have been filed with the IRS or how many of those have been approved, such revocations had been commonly viewed as difficult to obtain. One notable exception was under Regs. Sec. 1.754-1(c)(2), which permitted a partnership to revoke a Sec. 754 election that was in effect for its tax year that included Dec. 15, 1999. The revocation was effective for any transfers of interests or distributions that took place after that date. The government provided this relief because significant changes had been made to the regulations under Secs. 734(b), 743(b), and 755.
Revocation of Sec. 754 election
A partnership that files a Sec. 754 election may adjust the basis of partnership property under Secs. 734(b) and 743(b). The Sec. 754 election is made in a written statement included with the partnership return for the tax year in which a transfer of partnership interest or distribution of property occurs (Regs. Sec. 1.754-1(b)). For the election to be valid, the statement must contain information required in the regulations. Once made, the Sec. 754 election applies to all transfers of partnership interests and distributions of property for the partnership tax year for which the election is made and all subsequent tax years (Regs. Sec. 1.754-1(a)).
The revocation of a Sec. 754 election is allowed only if it is approved by "the district director for the internal revenue district in which the partnership return is required to be filed" (Regs. Sec. 1.754-1(c)(1)). The regulations state that the application for revocation must be filed not later than 30 days after the close of the partnership tax year for which the revocation is intended to take effect. The regulations also state that the application for revocation may be signed by any one of the partners. The instructions to the 2019 Form 1065, U.S. Return of Partnership Income, directed a partnership to file the revocation request "at the same IRS Submission Processing Center in which the partnership return is filed."The regulations do not prescribe a specific form on which to make the application for revocation, but they do provide examples of situations when there may be "sufficient reason" to approve the revocation application, as well as a reason that is not sufficient.
According to Regs. Sec. 1.754-1(c)(1), the following increased administrative burdens upon a partnership resulting from the election may be considered sufficient reason to approve a revocation application:
- A change in the nature of the partnership business;
- A substantial increase in the assets of the partnership;
- A change in the character of partnership assets; or
- An increased frequency of retirements or shifts of partnership interests.
The regulations provide that if a partnership requests revocation primarily to avoid stepping down the basis of partnership assets upon a transfer or distribution, then the revocation application will not be approved. This may no longer be as relevant as when the regulations were first finalized because of the requirement for a partnership to adjust the basis of partnership property under Sec. 743(b) if there is a substantial built-in loss (Sec. 743(d)) or make a Sec. 734(b) adjustment if there is a substantial basis reduction (Sec. 734(d)). These basis adjustments are mandatory even if the partnership does not have a Sec. 754 election in effect.
Technical terminations
In the abstract published in the Federal Register concurrently with the release of the draft Form 15254, Treasury and the IRS explained that Sec. 754 election revocation requests have increased since technical terminations were repealed under the TCJA for tax years beginning after Dec. 31, 2017. These so-called technical terminations were set forth in former Sec. 708(b)(1)(B) and provided an opportunity for new partnerships to decide anew on elections such as the Sec. 754 election.
Prior to the TCJA, former Sec. 708(b)(1)(B) provided that a partnership would terminate if 50% or more of the partnership's total interest in capital and profits was sold or exchanged within a 12-month period. Two events were then deemed to occur: First, the terminating partnership was deemed to contribute all of its assets and liabilities to a new partnership. Second, the partnership then terminated and was deemed to liquidate by distributing the interests in the new partnership to the remaining partners and the purchaser. The business was either continued by the new partnership or wound down.
One opportunity that technical terminations presented was for the new partnership to make new decisions on elections that would differ from the terminated partnership's decisions. A Sec. 754 election that had been put in place by the terminated partnership would not continue, so the new partnership could choose to make the Sec. 754 election or not. Such an opportunity would make a "revocation" of a Sec. 754 election possible without going through the actual application process. With the repeal of technical terminations under the TCJA, opportunities for a partnership to revoke a Sec. 754 election were limited to the revocation application.
New draft Form 15254
Though the regulations provide for a way to apply for a revocation of a Sec. 754 election as well as examples of sufficient reasons to revoke the election, it is not clear how many partnerships have been granted a revocation of a Sec. 754 election under the fact situations, because the IRS's approval or rejection of revocation applications is not public knowledge.
The new draft Form 15254 asks for the information of the partnership as well as the partnership tax year end in which the Sec. 754 election was made and the partnership tax year for which the revocation would begin. Part I of the form is titled "Information for All Requests." Under this part are three questions, with three subparts under question 2. Several of the questions in Part I mirror the examples from the regulations of reasons for which a revocation may be approved. The questions are:
- Has the partnership previously revoked a Sec. 754 election?
- Does the Sec. 754 election result in, or is it expected to result in, a substantial administrative burden to the partnership?
a. Has the nature of the partnership's business changed, or is it expected to change?
b. Has there been a substantial increase in the assets of the partnership or a change in the character of partnership assets?
c. Has there been, or is there expected to be, an increased frequency of retirements or shifts of partnership interests?
- Will the revocation of the Sec. 754 election result in an avoidance of a reduction in the basis of partnership assets under Sec. 734(b) or Sec. 743(b)?
Part II of draft Form 15254 is titled "Reason for the Request" and asks the partnership to explain its reason for filing the revocation request and to attach supporting documents. The last part of the form is the signature, which the instructions say must be made by a partner or LLC member authorized to sign the form. If someone else signs the form, a power of attorney via Form 2848, Power of Attorney and Declaration of Representative, must be attached.
Under the instructions for the draft Form 15254, the partnership must fill out Part II if it answered "yes" to any of the questions under numbers 2 or 3 and provide details on the nature of the changes and the circumstances leading to them. The instructions also give examples of supporting documents the partnership can include to provide more information on the change, including the background, nature, and structure of the business entity; a copy of the original Sec. 754 election; a copy of a prior request for revocation of a prior Sec. 754 election, including any correspondence with the IRS; Sec. 734(b) and/or Sec. 743(b) calculations that apply to the revocation tax year if the revocation was denied; and partner Schedule(s) K-1, Partner's Share of Income, Deductions, Credits, etc., showing how the Sec. 734(b) and/or Sec. 743(b) adjustments were allocated to the partner(s).
While the draft Form 15254 requests information similar to that mentioned in the regulations, the form does provide a procedure and uniform way of submitting an application for revocation of a Sec. 754 election. Further, it provides some insight about the types of documents and other factual information that the IRS may be looking at to determine whether a partnership has sufficient reason to be granted a revocation of its Sec. 754 election.
Observations
Even with the lack of data indicating the extent of the increase in the number of partnerships applying for revocations of Sec. 754 elections since the repeal of technical terminations, the increase seems to be substantial enough to warrant the IRS's developing a form. In the future, potentially eligible partnerships may more seriously consider requesting to revoke a Sec. 754 election in tax planning for future transactions involving changes in ownership.
Could the release of the draft form be a sign that the IRS is seeing more factual situations providing sufficient reason for the IRS to grant revocations of Sec. 754 elections? Should a partnership consider applying for a revocation of its Sec. 754 election if it is, for example, expecting a substantial increase in transfers of ownership that would produce minimal benefits from basis adjustments that would be outweighed by the costs to compute and report them? Either way, partnerships should still be cautious when deciding whether to make a Sec. 754 election and not assume that they would be able to successfully revoke the election in the future.
EditorNotes
Greg A. Fairbanks, J.D., LL.M., is a tax managing director with Grant Thornton LLP in Washington.
For additional information about these items, contact Mr. Fairbanks at 202-521-1503 or greg.fairbanks@us.gt.com.
Contributors are members of or associated with Grant Thornton LLP.
