Partnership Granted Relief for Late Section 754 Election

LLC Wins Extension After Inadvertent Filing Error

In a recent private letter ruling, the IRS granted Taxpayer X, a limited liability company treated as a partnership for tax purposes, a 120-day extension to file a late election under Section 754 of the Internal Revenue Code. Section 754 allows a partnership to adjust the basis of its assets when a partnership interest is transferred (under Section 743) or when the partnership distributes property to a partner (under Section 734). The ruling provides relief because X intended to make the election for the tax year ended 'Date 2' but inadvertently missed the original deadline. The IRS based its decision on the "good faith" standard outlined in Section 301.9100-3 of the Treasury Regulations, which governs extensions for regulatory elections.

The Mechanics of Relief: Good Faith and Basis Adjustments

The ruling provides relief because X, a limited liability company classified as a partnership for tax purposes, was formed on Date 1 and intended to make the election for the tax year ended Date 2 but inadvertently missed the original deadline. A partnership can elect under Section 754 to adjust the basis of partnership property. This election triggers basis adjustments under Section 734 and Section 743 when partnership interests are transferred or when the partnership distributes property. Specifically, Section 734 dictates how the basis of partnership property is adjusted after a distribution, while Section 743 dictates how the basis is adjusted after a transfer of a partnership interest. Once made, the Section 754 election applies to all distributions and transfers for the year it's filed and all subsequent years. The IRS based its decision on Section 301.9100-3 of the Treasury Regulations, which governs extensions for regulatory elections. Under this section, the IRS may grant an extension if the taxpayer acted reasonably and in good faith, and granting relief won't prejudice the government's interests.

Approval with Strings Attached: Retroactive Adjustments Required

While the IRS granted X a 120-day extension to file the Section 754 election, this approval came with a significant condition. The IRS stipulated that the ruling's validity hinges on X and its partners making retroactive adjustments to the basis of their properties and partnership interests. These adjustments must reflect what would have occurred had the Section 754 election been filed on time.

Specifically, X must retroactively calculate and account for any adjustments required under Section 734(b), which dictates how the basis is adjusted after a distribution of property, or Section 743(b), which dictates how the basis is adjusted after a transfer of a partnership interest. This includes "catching up" on any missed depreciation or other recovery of basis deductions for all open tax years. The IRS further clarified that these basis adjustments must be made irrespective of whether the statute of limitations on assessment or refund claims has expired for any relevant year. Any depreciation deductions for open years should be computed using the remaining useful life or recovery period, based on the adjusted property basis. Similarly, the affected partners must adjust the basis of their interests in X to reflect what that basis would be if the Section 754 election had been timely made.

Although this ruling, per Section 6110(k)(3) of the tax code, cannot be cited as precedent, it does suggest the IRS's willingness to provide relief for administrative errors regarding Section 754 elections when the government's interests are not prejudiced and the taxpayer acts in good faith.