Dec 1, 2010 12:00 PM

The importance of making an effective Section 754 election

By Yong Shuai

Limited partners (LPs) of family limited partnerships (FLPs) have long been a powerful estate-planning tool. LPs of FLPs can take a discount of as much as 75 percent for both estate and gift tax purposes, attributed to a lack of marketability and control and a fractional interest in an FLP.¹ But someone who inherits a partnership share in an FLP can face a huge disparity between his inside and outside basis in the partnership's assets. This disparity could result in increased capital gains and other types of taxes. Fortunately, the inheriting partner can maximize his tax benefits by making an Internal Revenue Code Section 754 election at the FLP level and funding the FLP with highly appreciated properties. The inheriting partner can get even more benefits if the FLP funding properties are depreciable ones.

IRC Section 742 states that the outside cost basis of an interest in a partnership that's acquired in a manner other than by contribution is determined by the following IRC sections: if the partnership interest is acquired by a purchase, the cost basis is the purchase cost (IRC Section 1012); if the partnership interest is inherited, the cost basis is normally equal to its fair market value (FMV) at the decedent's date of death or an alternative valuation date (IRC Section 1014); and if the partnership interest is a gift, the cost basis should be adjusted according to the gift tax and the generation-skipping transfer (GST) tax paid (IRC Sections 1015 and Section 2654).

Topics of Interest

Estate Tax	Donor Advised Funds
GSTs	Family Offices
Private Foundations	Life Insurance
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Topics of Interest

Estate Tax	Donor Advised Funds
GSTs	Family Offices
Private Foundations	Life Insurance
2010 Tax Act News	Industry Trends Surveys

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