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The Power of §754: > When Indie Ruff purchases a partnership interest, a Section 754 election allows the partnership to adjust the basis of its internal assets to match the price Indie paid. This "step-up" ensures Indie doesn't pay tax on gains that occurred before she joined, essentially giving her a $208,387 special basis adjustment.
The Power of §754: > When Indie Ruff purchases a partnership interest, a Section 754 election allows the partnership to adjust the basis of its internal assets to match the price Indie paid. This "step-up" ensures Indie doesn't pay tax on gains that occurred before she joined, essentially giving her a $208,387 special basis adjustment.
Indie's Inside Basis: > Equal to Reed’s basis before the sale: $1,032,613 (one-third of total partnership asset basis): $$1,032,613 \times 3 = \$3,097,839$
The Social Basis Adjustment Calculation:
Indie’s Outside Basis: $1,241,000
Minus: Indie’s Inside Basis: ($1,032,613)
= Special Basis Adjustment: $208.38
Treatment of "Hot Assets": The recapture potential in the equipment is assigned a $0$ basis and treated as a hot asset to preserve its ordinary income character.
Basis Reduction of "Cold Assets": Because the partnership’s basis in the distributed assets exceeded Reed’s remaining outside basis, a total reduction of $106,387 was required.
Pro-Rata Allocation: The decrease is allocated between the Investment and Equipment based on their relative tax bases ($71,000$ and $111,000$ respectively):
Investment Reduction: $106,387 \times (\$71,000 \div \$182,000) = \mathbf{\$41,503}$
Equipment Reduction: $106,387 \times (\$111,000 \div \$182,000) = \mathbf{\$64,884}$
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