What are some advantages and disadvantages of making a Section 754 election?
What will be an ideal response?
Advantages: Without a 754 election, if a new partner purchases a partnership interest when the partnership assets have a fair market value greater than their basis, the partner will be taxed on his/her proportionate share of any gain on a subsequent sale of these assets in addition to paying a higher purchase price for the partnership interest due to the assets' appreciation. The partner will not be able to recover this "double taxation" until the partnership is liquidated, which may be several years in the future. Sec. 754 prevents this timing problem by adjusting the partner's basis in partnership assets.
The Sec. 754 election has several disadvantages, including increased recordkeeping. Partners and/or the partnership must maintain separate records showing the calculation and allocation of the basis adjustment. Once a 754 election is made, adjustments are required on all subsequent sales and distributions, even if the adjustment decreases the basis. For distributions, the basis adjustment belongs to the partnership as a whole. The 754 election can only be revoked with IRS approval.
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