When you buy into a partnership or LLC that already owns real estate, you usually pay today’s value for an interest whose share of the property’s tax basis reflects years of old cost and accumulated depreciation. A section 754 election lets the partnership close that gap for you, and the extra depreciation it creates is easiest to understand with real numbers on the page.
As co-founder of Seneca Cost Segregation and a real estate investor myself, I’ve worked with investors who bought into an existing partnership and only learned about the step-up after the first K-1 arrived. Those calls go best when the buyer, the partnership’s CPA, and our engineers can all look at the same worked example before the return is filed.
Below, I size a step-up on one purchased interest, split it the way a cost segregation study would, and compare year one and year two under four outcomes. I also cover when the step-up qualifies for bonus depreciation, what the partnership has to file, and the mistakes that cost buyers the deduction.
TL;DR — Section 754 Depreciation Example
- ●A $1,000,000 buy-in can carry a $600,000 step-up: in our example, the gap between the price paid and the buyer’s share of the partnership’s old basis becomes extra basis that belongs to the buyer alone, and $550,000 of it lands on the depreciable building.
- ●The step-up starts a fresh recovery period: the regulations treat it as newly purchased property placed in service on the transfer date, so the buyer generally starts a new schedule instead of picking up the building’s remaining life.
- ●A study turns $14,168 into $153,484 of year-one depreciation: splitting the building step-up into 5-, 15-, and 27.5-year pieces lets the shorter-life portions take 100% bonus in our example.
- ●Inherited interests still benefit without bonus: the same study produced $32,484 in year one and $50,659 in year two for an heir, against $14,168 and $19,998 with no study.
- ●Bonus depends on how you acquired the interest: a purchase from an unrelated seller can qualify when the buyer had no prior interest in the property, while an inheritance or a related-party purchase does not, and a 734(b) step-up from a redemption never does.
- ●The election must ride on a timely partnership return: a missed election has a 12-month automatic relief window, and the buyer has 30 days to notify the partnership of the purchase.
How Section 754 Depreciation Works
Without an election, a buyer steps into the seller’s share of the partnership’s existing basis and nothing more.
Under section 743, the partnership adjusts the basis of its property after a transfer only if a section 754 election is in effect or there is a substantial built-in loss, meaning the property’s basis exceeds its value by more than $250,000 or the buyer would be allocated a loss of more than $250,000 on a sale at fair market value. For an appreciated rental property, the election is the only route to a step-up.
The 743(b) Adjustment Belongs to the Buying Partner
The step-up equals your outside basis (what you paid, plus your share of partnership debt) minus your share of the partnership’s inside basis, which the regulations also measure with your share of that debt included. The adjustment is yours alone, so the other partners keep depreciating their shares of the original basis exactly as before.
The same election also applies to section 734(b) adjustments on certain distributions, and the regulations at 26 CFR 1.754-1 keep it in effect for every later year unless the IRS approves a revocation. A partnership that elects for one buyer is signing up for every future transfer and distribution, including ones that reduce basis.
The Step-Up Starts a New Recovery Period
The portion of the step-up allocated to depreciable property is treated as newly purchased recovery property placed in service when the transfer occurs. Treasury Regulation 1.743-1 adds that any applicable recovery period and method may be used for that increased basis.
For a residential building, that generally means a new 27.5-year schedule starting in the month of your purchase, regardless of when the partnership bought the property. A narrow exception applies when the partnership uses the remedial allocation method for property a partner contributed. For a commercial building, it is a new 39-year schedule, and components identified as 5-, 7-, or 15-year property follow those shorter lives.
Walk Through a Section 754 Depreciation Example
Every number in this walkthrough is a hypothetical input, picked so you can check the arithmetic by hand.
Measure the Step-Up on the Purchased Interest
Suppose a two-member LLC taxed as a partnership bought an apartment building in 2016 and carries no debt. In April 2026, an unrelated investor buys the departing member’s 50% interest for $1,000,000.
The buyer’s outside basis is the $1,000,000 purchase price, and its share of inside basis is $400,000. With a section 754 election in place, the 743(b) step-up is $600,000.
Allocate the Step-Up Under Section 755
Section 755 assigns the step-up asset by asset, based on the gain the buyer would be allocated if the partnership sold everything at fair market value right after the purchase. Here, $50,000 lands on the land and $550,000 on the building.
The land piece is never depreciable, which is why the land and building split deserves the same care it gets in a direct purchase, as our guide on how to determine land value explains. What we see consistently when coordinating with CPAs on partnership buy-ins is that the land question gets settled quickly while the building step-up gets booked as one 27.5-year asset without anyone looking inside it.
A cost segregation study looks inside it. In our hypothetical, the study attributes the $550,000 building step-up to three recovery classes, based on each component’s value and the partnership’s basis in it.
The 27.5-year rate reflects 8.5 months of service under the mid-month convention for an April placement, using the 3.636% full-year rate in IRS Publication 946. Our overview of depreciation schedules for building components covers how each class recovers over time. The 5- and 15-year rates assume the half-year convention, which would change if more than 40% of the depreciable property the partnership places in service that year lands in the last quarter.
Compare Year-One Depreciation Under Four Outcomes
The buyer receives these amounts on top of its share of the partnership’s ordinary depreciation on the original basis for the part of the year it owns the interest. Outcome D assumes that, instead of a sale, the same member died in April 2026 and an heir received the interest.
Outcome C produces more than ten times the extra depreciation of outcome B from the same $550,000 of building step-up. Outcome D shows why a study can still pay off for an heir who cannot claim bonus.
Track the Second Year of Recovery
Year two shows where the deductions go once the first-year effects pass.
Over the full recovery periods, outcomes B, C, and D each recover the same $550,000 of building step-up. The study changes how quickly that basis comes back to the buyer, and outcome A recovers none of it through depreciation.
Confirm When the Step-Up Qualifies for Bonus Depreciation
The 100% rate in outcome C depends on how the interest changed hands, and the rules are tested at the partner level.
- ●Purchase timing: qualified property acquired and placed in service after January 19, 2025 is eligible for 100% bonus, and a purchase under a written binding contract signed on or before that date does not count, under the changes our page on the One Big Beautiful Bill and bonus depreciation covers.
- ●No prior interest: neither the buyer nor a predecessor can have held a depreciable interest in the portion of the property the step-up is allocated to, with the general lookback covering the five calendar years before the purchase year plus the part of that year before the transfer.
- ●Unrelated seller: the purchase has to meet the related-party limits of section 179(d)(2), and Treasury Regulation 1.168(k)-2 compares the seller of the interest with the buyer to decide relatedness.
- ●Inherited interests: an interest whose basis is set under section 1014 at death fails the purchase test, so an heir’s step-up follows regular MACRS schedules.
- ●Redemptions are different: a step-up under section 734(b), which can arise when the partnership distributes cash or property, including when it buys out a partner, never qualifies for bonus.
- ●State returns: some states decouple from federal bonus, as our page on California’s treatment of bonus depreciation shows, so model the state add-back alongside the federal benefit.
The partnership can also elect out of bonus by class for a buyer who would rather spread the deduction. Each partner’s 743(b) adjustment in each recovery class counts as a separate class, so the choice for one buyer’s step-up leaves the other partners and the partnership’s own property untouched.
File the Election and Report the Depreciation
The paperwork is short, and the deadlines matter more than the wording.
What the Election Statement Must Include
The partnership attaches a written statement to its return for the year of the transfer, filed on time with extensions. The statement gives the partnership’s name and address and declares that it elects under section 754 to apply sections 734(b) and 743(b).
- ●Missed the deadline: the section 754 election is on the list of elections that get an automatic 12-month extension under Treasury Regulation 301.9100-2, measured from the return’s due date including any extension, with “FILED PURSUANT TO § 301.9100-2” at the top of the filing.
- ●Buyer’s notice: a buyer who purchases an interest while an election is in effect must notify the partnership in writing within 30 days of the sale.
- ●Partnership’s statement: the partnership attaches a statement to its return for the year of the transfer giving the buyer’s name and taxpayer identification number, the computation of the adjustment, and the assets it was allocated to.
- ●Later years: once made, the election carries forward, so later returns need no new election statement, though each later transfer needs its own adjustment statement.
How the Buyer’s Depreciation Reaches the K-1
The step-up is tracked separately from the partnership’s common basis. Under the Partner’s Instructions for Schedule K-1, a net negative income adjustment from all 743(b) adjustments, which is what extra depreciation on a step-up usually produces, goes to the buyer in box 13 with code V. A net positive adjustment would go in box 11 with code F, and the remaining adjustment net of cost recovery appears by asset grouping in box 20 with code U.
The buyer then applies its own basis, at-risk, and passive activity limits to that deduction. Our guide to handing study results to your CPA covers what the partnership’s preparer needs from the study to fill in those codes.
Mistakes to Avoid With Section 754 Depreciation
Each of these is common and avoidable.
- ●Buying without asking about the election: if the partnership has no election and will not make one, the step-up never happens. Make the election a closing item in the purchase agreement.
- ●Depreciating the step-up over the remaining life: the increase is treated as newly placed in service, so carrying over the partnership’s old schedule misstates the deduction every year. Start a new schedule on the transfer date.
- ●Booking the whole building step-up as 27.5-year property: shorter-life components hidden in that number lose their faster recovery and any bonus. Have the building portion studied before the first return closes.
- ●Assuming every transfer gets bonus: inherited interests, related-party purchases, and 734(b) adjustments fall outside the bonus rules. Confirm how the interest was acquired before modeling year one.
- ●Ignoring the passive rules: a large first-year deduction from a rental partnership is usually passive, and our guide on whether bonus depreciation can create a loss explains where that loss lands. Model the buyer’s own limits before the partnership decides whether to elect out of bonus for the buyer’s step-up.
- ●Forgetting the 30-day notice: the partnership is not required to make the adjustment until it has been notified of the purchase. Send the written notice as soon as the purchase closes.
Frequently Asked Questions
Below are the questions we hear most from investors buying into, or inheriting, a real estate partnership interest.
How Seneca Supports Partnership Interest Purchases
A 743(b) step-up is only as useful as the component detail behind it. At Seneca, cost segregation is the only service we offer, and our in-house engineers break down every component of the property behind your interest, using an onsite visit or a virtual tour, whichever you choose. Our Head of Engineering reviews and signs off on each study before it goes to your CPA.
A dedicated Project Manager, our Engineering team, and an Advisor stay on your file, with real-time updates through each stage of the study. Audit defense comes with every report, supported by 10,200+ properties assessed and zero IRS audits triggered or lost, and we also handle Qualified Production Property (QPP) studies. You can run your own numbers in our cost segregation calculator before the partnership files.
Conclusion
A section 754 election turns the premium you pay for a partnership interest into extra basis that is yours alone, and the share that lands on the building and its components can be depreciated. In the example above, the same $600,000 step-up produced nothing without the election, $14,168 with the election alone, and $153,484 once a study split the building portion and bonus applied.
The decision has to be made on the partnership’s return for the year of your purchase, so raise it before closing and get the study scheduled early. Our longer guide to cost segregation and bonus depreciation is a good next read, and a free estimate from our team will show how much of your step-up could move to shorter lives.
