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When you buy a partnership interest or inherit one, the price you paid becomes your basis in the interest, but the partnership's basis in its underlying property does not change. Without a Section 754 election in place, your depreciation continues to be computed on the partnership's old, often much lower, basis in the property. A Section 754 election allows a special basis adjustment under Section 743(b) that effectively steps up your share of the inside basis to match what you paid. That adjustment can be allocated across the partnership's assets and depreciated, and a cost segregation study is what determines how much of it lands on faster-recovery property.
A retired dentist in Grand Junction, Colorado bought a 25 percent interest in a partnership that owns a small office and retail building. He paid $900,000 for the interest, which reflected what the building is worth now. The partnership had bought the building in 2009 for a fraction of that, and had been depreciating it ever since.
His first K-1 arrived and the depreciation allocated to him was small. He assumed it was an error. He had just paid $900,000. Where was the depreciation on $900,000?
It did not exist, because the partnership had not made a Section 754 election. His outside basis, his basis in the partnership interest itself, was $900,000, exactly what he paid. But the partnership's inside basis, its basis in the actual building, was still the 2009 number minus seventeen years of depreciation already taken. His depreciation was computed on that old, heavily depreciated number, not on his purchase price.
He had bought at 2026 prices and inherited a 2009 depreciation schedule. This article explains why that happens, and what the election is that fixes it.
The whole issue lives in a distinction that partnership taxation makes and most investors have never heard of.
Your outside basis is your basis in your partnership interest. When you buy an interest, your outside basis is what you paid. Straightforward.
The partnership's inside basis is the partnership's basis in the assets it owns. When the partnership bought the building in 2009, its basis was the 2009 cost. That basis has been reduced by depreciation every year since.
Here is the disconnect. When one partner sells an interest to a new partner, the partnership itself has not bought or sold anything. The building did not change hands. So by default, the partnership's inside basis in the building is completely unaffected by the price the new partner paid. The new partner steps into a share of the existing, old, depreciated inside basis.
The result is a mismatch. You paid current market value on the outside. Your depreciation runs off a decades-old number on the inside. Every year, you are underclaiming depreciation relative to your actual investment, and the gap can be enormous on a property that has appreciated.
Section 754 lets a partnership elect to adjust the basis of its property when certain events occur. Two provisions do the work.
Section 743(b) applies on the transfer of a partnership interest, whether by sale or exchange or on the death of a partner. When a 754 election is in effect, the partnership makes a special basis adjustment with respect to the transferee partner only. The effect is to bring that partner's share of inside basis into line with what they paid for the interest.
Section 734(b) applies to certain distributions from the partnership and adjusts the basis of remaining partnership property. That path matters in redemption and distribution situations rather than a straight purchase, and it has its own rules.
The critical feature of a 743(b) adjustment is that it belongs to the transferee partner alone. It does not change anything for the other partners, and it does not alter the partnership's common basis. It is a personal adjustment that rides with the new partner's interest, which is why partnerships track it separately.
For the dentist in Grand Junction, a 754 election would produce a 743(b) adjustment reflecting the difference between his $900,000 purchase price and his share of the partnership's old inside basis. That adjustment is then allocated among the partnership's assets under the applicable rules, and the portion allocated to depreciable property can be depreciated.
Now the connection that most people miss, and the reason this topic belongs in a cost segregation library.
The 743(b) adjustment does not arrive as one undifferentiated lump. It gets allocated among the partnership's assets according to the rules, and how it lands across those assets determines how fast it is recovered.
An adjustment allocated to land is not depreciable at all, because land never is. An adjustment allocated to the building structure recovers over the long statutory life, 39 years for nonresidential real property or 27.5 for residential rental. An adjustment allocated to property with shorter recovery periods comes back far faster.
That allocation depends on knowing what the partnership's property actually consists of, at a component level, with supportable values. Which is precisely what a cost segregation study produces. Without a component-level analysis, the allocation defaults to the coarse categories anyone can see on a depreciation schedule, and a large share of the step-up ends up parked on the slowest possible recovery period.
There is a further point worth raising with your CPA. Depending on the specific facts and the applicable rules, a portion of a 743(b) adjustment allocated to qualifying property may be eligible for bonus depreciation. The rules governing bonus eligibility for basis adjustments are technical, they turn on how the property was acquired and on related-party and prior-use considerations, and they are genuinely a CPA determination rather than something to assume. But where it applies, and with 100 percent bonus depreciation restored permanently by the One Big Beautiful Bill Act, signed into law on July 4, 2025, for qualifying property, the timing difference is substantial. This is a question to put to your tax advisor directly rather than to take for granted in either direction.
The same mechanism matters at death, and here the stakes are often larger.
When a partner dies, the heir generally receives a stepped-up basis in the partnership interest, reflecting value at death. That is outside basis. Once again, the partnership's inside basis in its property is unchanged by the death of a partner.
So an heir can inherit an interest worth several million dollars, have an outside basis reflecting that value, and still receive K-1s showing depreciation computed on property basis established decades earlier by a parent or grandparent. The step-up that estate planning secured on the outside never reaches the inside without a 754 election.
For families holding real estate in partnerships across generations, this is one of the most commonly missed items in the entire transition. The estate work gets done carefully. The partnership-level election gets overlooked, and the heirs quietly underclaim depreciation for years.
A 754 election is not automatically correct, and a responsible discussion includes what it costs.
The election is generally binding on the partnership for the year made and subsequent years, and revoking it requires IRS consent. That means you are not electing for one favorable transaction. You are committing the partnership to make basis adjustments on future qualifying transfers and distributions as well, and those will not always be favorable. A 743(b) adjustment can be negative, stepping basis down, when an interest transfers at a value below the transferee's share of inside basis. In a declining market or a distressed transfer, the election can work against the new partner.
There is also real administrative burden. The partnership must track adjustments partner by partner, maintain separate depreciation computations for each partner's adjustment, and report accurately. For a partnership with frequent transfers, this compounds. Sponsors and general partners often resist making the election for exactly this reason, which is worth knowing if you are the incoming partner who wants it.
There are also situations where a basis adjustment is mandatory rather than elective, including certain transfers where the partnership has a substantial built-in loss. Whether that applies is a technical determination.
Keith Cunningham's discipline is the right one here. The election looks like free money to an incoming partner and looks like permanent administrative cost to a general partner. Both are true. The question is the net across the partnership's realistic future, not the single transaction in front of you.
If you are buying into a real estate partnership, ask whether a Section 754 election is in place before you close, not after. It is a term you can negotiate. An incoming partner has real negotiating power on this point, and the difference in your after-tax return over a hold period can be significant. If the election is not in place and the general partner will not make it, that is information you should price into what you are willing to pay.
If you have inherited a partnership interest, raise the question with the estate's advisors and with the partnership. The outside step-up your family secured may not be reaching your depreciation at all.
If you are a general partner, understand that the election is a meaningful benefit you can offer incoming partners, and that the administrative burden is manageable with proper records. Refusing it reflexively may cost you on price.
In every one of those situations, the size of the benefit depends on where the adjustment lands across the partnership's assets. That is the component-level question, and it is what an engineered cost segregation study answers. The Cost Seg America team has completed more than 16,000 studies and defended studies through more than 125 IRS audits with zero losses and zero dollars ever returned to the IRS. On a partnership property where a step-up is being allocated, that documented component analysis is what turns a paper adjustment into recovered depreciation.
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What is a Section 754 election?
It is an election a partnership makes to adjust the basis of its property when certain events occur, including transfers of partnership interests under Section 743(b) and certain distributions under Section 734(b). It aligns an incoming partner's share of inside basis with what they actually paid.
Why is my depreciation so low after buying into a partnership?
Because without a 754 election, the partnership's basis in its property is unaffected by what you paid for your interest. Your depreciation runs off the partnership's original, already-depreciated basis rather than your purchase price.
Does a 743(b) adjustment affect the other partners?
No. A 743(b) adjustment applies only with respect to the transferee partner. It does not change the other partners' positions or the partnership's common basis, which is why partnerships track it separately.
Does this apply when I inherit a partnership interest?
Yes. An heir generally receives a stepped-up outside basis in the interest, but the partnership's inside basis is unchanged. Without a 754 election, the step-up never reaches the depreciation the heir claims. This is one of the most commonly missed items in generational real estate transfers.
Is a 754 election always a good idea?
No. It is generally binding on future years and requires IRS consent to revoke, so it also applies to future transfers where the adjustment may be negative. It carries real administrative burden as well. The analysis should weigh the partnership's realistic future, not just the transaction at hand.
How does cost segregation affect the step-up?
The adjustment is allocated among the partnership's assets, and how it lands determines how quickly it is recovered. Amounts allocated to land are not depreciable, amounts on the building recover slowly, and amounts on shorter-life property recover faster. An engineered component study supports that allocation.
Can the step-up qualify for bonus depreciation?
Depending on the specific facts and applicable rules, a portion allocated to qualifying property may be eligible, but the rules are technical and turn on acquisition and prior-use considerations. This is a determination for your CPA rather than an assumption to make in either direction.
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