Category: Partnerships
Subject: Section 754 Election
Title: Effect of 754 Election and Subsequent Foreclosure Gain
IRC Sections: 754
Filename: 1035.html
Date Produced: 12/97

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Background

Taxpayer is the general partner of a limited partnership. The partnership owns real property encumbered by nonrecourse mortgage in the amount of $2,445,551. For purposes of this exercise, I arbitrarily used $2,000,000 as the inside basis of the property.

The taxpayer recently purchased for a nominal sum, say $1, the partnership units of several of the other limited partners whose interests aggregate 9.9% of the partnership.

The partnership is contemplating forfeiting the property to the lender.

It seems to me the taxpayer's outside basis in the purchased limited partnership units is $1 plus the selling LP's share of partnership debt. Sections 1012 and 752. The inside basis of partnership property will not change unless the partnership has in effect (or makes) a Section 754 election. Section 743.

Foreclosure of property subject to nonrecourse indebtedness gives rise to gain measured by the difference between the full amount of the outstanding debt versus the basis of the foreclosed property. Reg. Section 1.1001-2(a). The fair market value of the security is irrelevant to this result. Reg. Section 1.1001-2(b). Tufts, John v. Com., (1978) 70 TC 756, revd(1981, CA5) 48 AFTR 2d 81-5660, 651 F2d 1058, 81-2 USTC ¶9574, revd(1983, S Ct) 51 AFTR 2d 83-1132, 461 US 300, 75 L Ed 2d 863, 83-1 USTC ¶9328, affd on remand(1983, CA5) 52 AFTR 2d 83-5759, 712 F2d 199, 83-2 USTC ¶9674.

If the partnership has or makes an election under Section 754, the inside basis of partnership property will be adjusted to the extent of the difference between the taxpayer's cost of the purchased LP units and the basis of those units in the hands of the selling LP's. This basis step-up is personal to the taxpayer, the purchasing partner, and would serve to decrease the amount of gain recognizable by the taxpayer on disposition of the property. For purposes of this exercise, I have assumed that the selling LP's outside basis is equal to their share of the inside basis of partnership property.

If the partnership does not make an election under Section 754, the purchasing partner will recognize 9.9% of any foreclosure gain. On the other hand, however, if a Section 754 election is in effect, the purchasing partner will recognize no foreclosure gain. See the attached illustrative computations.