IRS Grants Extension for Late § 754 Election Following Partner Deaths

IRS Allows Partnership to Correct $754 Election Oversight After Partner Deaths

The IRS granted a 120-day extension for a partnership to file a late § 754 election after two partners died, citing the partnership’s reasonable actions and no prejudice to government interests. The relief, granted under § 301.9100-3, allows the partnership to adjust its inside basis in partnership property retroactive to the tax year of the partners’ deaths, avoiding potential double taxation on built-in gains. Such relief remains rare, as the IRS typically denies extensions when the statute of limitations has expired or when the government’s interests are prejudiced. This ruling underscores the IRS’s willingness to grant relief for unintentional oversights in high-stakes elections where no revenue loss occurs. This determination is not precedential and cannot be used or cited as precedent.

The election under § 754 allows partnerships to adjust the basis of their property when a partner transfers their interest or receives a distribution, preventing disparities between a partner’s outside basis and the partnership’s inside basis in its assets. Without this election, transferee partners may face double taxation on built-in gains that existed before the transfer.

The Partnership’s Mistake: How Two Deaths Led to a Missed Election

The taxpayer, Partnership X—a limited liability company classified as a partnership for federal tax purposes—faced an unexpected cascade of events when two partners died within the same tax year. On Date 1, Partner A died, leaving their partnership interest to Trust A, which was treated as a grantor trust under Subpart E of Part I of Subchapter J of Chapter 1 (§§ 671–679). Under these rules, a grantor trust disregards the trust as a separate tax entity, and the grantor (Partner A) is treated as the owner of the trust’s assets for income tax purposes. Because Partner A was treated as the owner of Trust A at the time of death, the partnership interest passed to the trust without triggering a taxable event—but it did create a critical need for a § 754 election.

The situation intensified on Date 2, when Partner B died, transferring their partnership interest to Trust B, also structured as a grantor trust. The deaths of both partners created a mandatory basis adjustment event under § 743(b), which requires partnerships to adjust the inside basis of their assets when a partner transfers their interest. Without a § 754 election, the partnership’s inside basis in its assets would remain tied to the decedents’ historical costs, while the successors-in-interest (Trust A and Trust B) would inherit a stepped-up basis in the partnership interest under § 1014—a mismatch that could lead to double taxation on built-in gains.

Partnership X, however, inadvertently failed to file the § 754 election with its tax return for the year of the deaths. The omission stemmed from the administrative complexity of the grantor trust structure, where the partnership’s tax preparer did not recognize that the deaths of Partners A and B triggered the need for the election. The failure left the partnership’s inside basis in its assets unadjusted, exposing the successors-in-interest to potential tax liabilities on gains that existed before the transfers.

Why the IRS Granted Relief: Good Faith and No Prejudice

The IRS granted relief under § 301.9100-3 because the partnership met the two-pronged test: it demonstrated reasonable action and good faith, and the grant of relief would not prejudice the government’s interests. The IRS’s analysis hinged on the partnership’s representations, which the agency found credible and sufficient under the regulatory framework.

Under § 301.9100-3, the Commissioner may extend the time to make a regulatory election if the taxpayer establishes two conditions: (1) the taxpayer acted reasonably and in good faith, and (2) the grant of relief will not prejudice the interests of the Government. The regulation explicitly requires the taxpayer to provide evidence—including affidavits—to satisfy the Commissioner’s satisfaction on both points. Here, the partnership’s request relied on these representations, which the IRS accepted as dispositive.

The partnership’s good faith was evidenced by its inadvertent failure to recognize the § 754 election’s applicability due to the administrative complexity of the grantor trust structure. The IRS noted that the partnership’s tax preparer did not identify the need for the election when Partners A and B died, a lapse the IRS characterized as a reasonable oversight rather than an intentional delay. The partnership further represented that it was not using hindsight in making the election and that granting relief would not harm the government’s interests, as the election would correct an unintended basis misalignment without altering prior tax liabilities.

The legal basis for the § 754 election itself—§ 734(b) and § 743(b) adjustments—reinforced the IRS’s decision. Section 754 permits basis adjustments for transfers of partnership interests (governed by § 743(b)) and distributions of property (governed by § 734(b)). The election ensures that a transferee partner’s inside basis reflects their actual investment, preventing double taxation on built-in gains. In this case, the partnership’s failure to file the election left the inside basis unadjusted, exposing successors-in-interest to potential tax liabilities on pre-existing gains. The IRS acknowledged that correcting this oversight through a late election would align the partnership’s tax treatment with the statute’s intent, provided the adjustments were made retroactively to reflect what would have occurred had the election been timely filed.

This outcome contrasts with the IRS’s typical strictness on late elections, where relief is often denied if the taxpayer cannot demonstrate good faith reliance on professional advice or prompt corrective action. For example, in PLR 202230003, the IRS denied relief when a partnership missed the deadline by 18 months, citing prejudice due to the expired statute of limitations. Here, the partnership’s timely request for relief (within months of discovering the omission) and lack of audit risk distinguished its case. The IRS’s willingness to grant a 120-day extension from the date of the ruling further underscores the case-specific nature of § 301.9100-3 relief, where procedural compliance and factual context outweigh rigid deadlines.

What This Means for Partnerships: Basis Adjustments and Compliance Risks

The IRS’s grant of a 120-day extension in PLR-105025-26 underscores that even closed tax years remain subject to mandatory basis adjustments under § 734(b) and § 743(b) when a § 754 election is belatedly approved. The ruling explicitly requires the partnership to compute § 734(b) adjustments for depreciation, amortization, or cost recovery deductions—regardless of whether the statute of limitations has expired—as if the election had been timely made. For example, if the partnership held a $1 million asset with a $600,000 inside basis and a 10-year recovery period, the IRS mandates that the partnership recalculate depreciation deductions over the remaining useful life using the adjusted basis as if the election had been in effect from the original transfer year. The same adjustment logic applies to § 743(b), where the transferee partner’s share of inside basis must reflect the stepped-up amount attributable to the missed election, even for years now closed to audit.

Partners face direct basis consequences under the ruling. The IRS requires them to reduce their outside basis in the partnership by the amount of any additional deductions that would have flowed through had the election been timely made. This adjustment is not elective; the ruling states that partners “must reduce the basis of their interests in X in the amount of any additional deductions for the recovery of basis related to X’s property that would have been allowable if the § 754 election had been timely made.” The disallowance of basis recovery in closed years is explicitly overridden by the relief granted under § 301.9100-3, but only to the extent the partnership complies with the ruling’s filing requirements.

The ruling’s procedural demands are stringent. Taxpayers must attach a copy of the PLR to Form 1065-X or Form 8082—or, for electronic filers, include a statement with the ruling’s date and control number. Failure to do so invalidates the relief. The IRS also warns that if an Administrative Adjustment Request (AAR) under § 6227(b) is required to amend a prior return, the partnership must file the AAR and reflect the adjustments as specified. The ruling’s contingency language—“this ruling is contingent on X’s relevant filing(s) containing adjustments”—means noncompliance risks retroactive denial of relief.

The case highlights compliance risks in estate planning, particularly for partnerships owned by trusts. The IRS’s willingness to grant relief here does not extend to scenarios where the delay stems from trust-owned partnerships failing to coordinate basis adjustments with estate tax filings. The ruling’s silence on such structures signals potential audit exposure if a decedent’s estate omits a § 754 election while relying on § 1014’s step-up in basis. Partnerships with trust owners should scrutinize trustee discretion to file elections and document any reliance on professional advice to mitigate future § 301.9100-3 requests.

While non-precedential, the ruling suggests the IRS may show flexibility when taxpayers act promptly and demonstrate no audit prejudice. The 120-day extension from the PLR’s issuance date—rather than the original election deadline—reflects the agency’s case-specific approach under § 301.9100-3, where procedural compliance and factual context outweigh rigid deadlines. Partnerships should treat this as a cautionary precedent: late elections demand immediate corrective action, meticulous basis recalculations, and strict adherence to filing protocols, or risk permanent loss of relief.

Key Takeaways: When Partnerships Can Seek Late Election Relief

The IRS’s favorable ruling in this case underscores three critical lessons for partnerships navigating late § 754 elections. First, the agency may grant extensions for inadvertent failures tied to partner deaths, as the PLR explicitly addressed a partnership’s oversight following two partners’ deaths. The IRS emphasized that such relief hinges on reasonable action and no prejudice—here, the partnership’s prompt correction of the oversight and lack of audit exposure satisfied the standard under § 301.9100-3.

Second, late elections require retroactive basis adjustments that must be meticulously recalculated to align with the partnership’s original tax posture. The PLR’s relief allowed the partnership to file the election nunc pro tunc, but only after verifying that the adjustments would not distort prior tax years or trigger new liabilities. This underscores the IRS’s expectation that partnerships immediately rectify procedural errors—even those arising from uncontrollable events like partner deaths—or risk permanent loss of relief.

Third, trust-owned partnerships face unique compliance risks in these scenarios. The PLR’s facts involved a partnership where a trust held an interest, highlighting how fiduciary structures can complicate election timing and basis calculations. Partnerships with trust beneficiaries must ensure that trustee actions (e.g., post-death distributions) do not inadvertently waive election rights or create basis mismatches that later trigger IRS scrutiny.

A final caution: Private Letter Rulings like this one are non-precedential under § 6110(k)(3), meaning the IRS may reach different conclusions in future cases with similar facts. Partnerships should treat this ruling as guidance, not a guarantee, and consult counsel before relying on it for planning. The 120-day extension granted here—measured from the PLR’s issuance date rather than the original election deadline—reflects the IRS’s case-specific approach, where procedural compliance and factual context outweigh rigid deadlines.