Can a Single-Member LLC Make a 754 Election?

A 754 election allows certain business entities to adjust the tax basis of their assets when ownership changes, potentially providing tax benefits. While partnerships commonly use this election, single-member LLCs face unique challenges due to their tax classification.

Understanding whether a single-member LLC can make a 754 election requires examining its classification and potential transition to partnership status.

Requirements for 754 Election

To make a 754 election, a business must be classified as a partnership for tax purposes under Subchapter K of the Internal Revenue Code. This election allows a partnership to adjust the basis of its assets when ownership changes, such as a partner’s death or the sale of a partnership interest. The election must be formally filed with the IRS.

The election applies to two types of basis adjustments: Section 743(b) and Section 734(b). A Section 743(b) adjustment occurs when a partnership interest is transferred, allowing the incoming partner to adjust their share of the inside basis to reflect the purchase price. A Section 734(b) adjustment applies when a partnership distribution creates a disparity between the inside and outside basis of the remaining partners. These adjustments help align the tax basis of assets with their fair market value, reducing taxable gains or increasing depreciation deductions.

To elect 754 treatment, the partnership must file a written statement with its timely filed tax return, including extensions, for the year in which the ownership change occurs. The statement must explicitly declare the election under Section 754 and be signed by a partner authorized to act on behalf of the entity. Once made, the election remains in effect for all future years unless revoked with IRS approval.

Classification Considerations for Single-Member LLCs

A single-member LLC (SMLLC) is treated as a disregarded entity by default for federal tax purposes, meaning its income and expenses are reported directly on the owner’s tax return. The IRS does not recognize it as a separate tax entity unless it elects corporate taxation. While this simplifies tax reporting, it also limits the elections available to the entity, including the ability to make a Section 754 election.

Since an SMLLC is not considered a partnership, it does not fall under Subchapter K, which governs partnership taxation. Without partnership status, it cannot make a 754 election because there is no partnership interest to transfer or adjust. Any ownership transfer is treated as a direct sale or gift by the individual owner, leaving the tax basis of assets unchanged.

If an SMLLC elects corporate taxation by filing Form 8832, it still does not qualify for a 754 election. Corporations follow different rules for basis adjustments, primarily through Section 338 elections, which apply to stock purchases rather than partnership interest transfers. An entity must be taxed as a partnership—not just structured as an LLC—to use a 754 election.

Transition to Partnership Status

An SMLLC can become eligible for a 754 election by adding a second member, resulting in partnership tax treatment under the Internal Revenue Code. This transition occurs when another person or entity acquires an ownership interest through a sale, capital contribution, or issuance of a new membership stake. Once the LLC has at least two members, it is automatically classified as a partnership for tax purposes unless it elects corporate taxation.

The method of adding a member affects the tax consequences. If the original owner sells part of their interest, the transaction is treated as a sale of a partnership interest under Section 721, which generally allows for non-recognition of gain or loss if structured properly. If the new member contributes capital in exchange for an interest, the LLC must determine profit and loss allocations based on the operating agreement. The formation of a partnership also requires compliance with IRS reporting obligations, including filing Form 1065 and issuing Schedule K-1s to members.

Filing the Election

Once an LLC transitions to a partnership, filing a 754 election requires following IRS procedures carefully. The election must be submitted with the partnership’s timely filed Form 1065, including extensions, for the tax year in which a triggering event—such as the sale or transfer of a partnership interest—occurs. The filing should include a written statement signed by an authorized partner, explicitly declaring the election under Section 754.

The IRS does not provide a standardized form for this election, so the statement must clearly reference Section 754 and specify that the partnership elects to adjust the basis of its property under Sections 734(b) and 743(b). Because the election is binding for all future years, the partnership should assess its long-term tax strategy before proceeding. Revocation requires IRS approval and is typically granted only in cases of undue hardship or significant business changes.

Basis Adjustments Under 754

A 754 election enables adjustments to the tax basis of partnership assets under Sections 734(b) and 743(b), depending on the nature of the ownership change. These adjustments align the tax basis of partnership property with its fair market value, affecting depreciation, amortization, and gain or loss recognition when assets are sold.

Section 743(b) adjustments occur when a partnership interest is transferred due to sale or inheritance. The new partner’s share of the inside basis is adjusted to reflect the purchase price or fair market value at the time of transfer. For example, if a partner buys into a partnership where the book value of assets is significantly lower than their market value, a 743(b) adjustment ensures the new partner receives a stepped-up basis in their share of the assets. This prevents them from recognizing excessive taxable gains when the partnership disposes of those assets in the future. The adjustment applies only to the incoming partner and does not affect the basis of other partners.

Section 734(b) adjustments apply when the partnership makes a distribution that alters the remaining partners’ inside and outside basis. If a partner receives a distribution that reduces their outside basis below the partnership’s inside basis in the assets, the partnership can adjust the basis of its remaining assets to prevent distortions in future tax calculations. This adjustment is particularly relevant in liquidating distributions, ensuring that the remaining partners do not inherit an artificially high or low basis in the partnership’s assets. While these adjustments provide tax benefits, they require meticulous record-keeping to track changes in basis over time and ensure IRS compliance.