How to Revoke a Section 754 Election Using Rev. Proc. 96-58
Learn how partnerships can use Rev. Proc. 96-58 to revoke a Section 754 election when its administrative burden no longer justifies the tax benefits.
A partnership may seek to revoke a Section 754 election if the administrative requirements become too burdensome. While the election can be beneficial, it is not permanent. However, revoking the election is not an automatic process and requires receiving consent from the Internal Revenue Service (IRS) after formally requesting permission and providing a valid reason.
Understanding the Section 754 Election
A partnership makes a Section 754 election to address potential inequities that arise from the difference between a partner’s basis in their partnership interest and the partnership’s basis in its assets. A partner’s “outside basis” is their investment in the partnership, which changes over time. The “inside basis” refers to the partnership’s basis in the assets it owns. These two values can diverge significantly, especially when a new partner joins by purchasing an interest from an existing partner.
For instance, imagine a new partner pays $500,000 for a partnership interest. This $500,000 is their outside basis. If the partnership then sells an asset in which its share of the inside basis is only $100,000, the new partner could be allocated a significant taxable gain. The Section 754 election prevents this by allowing the partnership to adjust the inside basis of its assets for the new partner, which aligns their share of the inside basis with their outside basis.
This election is made by filing a statement with the partnership’s timely filed tax return for the year it is to become effective. Once made, the election is binding for that year and all future years unless the IRS consents to a revocation. While beneficial, tracking these basis adjustments for each partner can become an administrative headache due to the complexity and cost of maintaining separate accounting records.
Requirements for Requesting a Revocation
The IRS Commissioner has the authority to grant revocations, but the partnership must provide sufficient reason for the request. The IRS will not approve a request made primarily to avoid reducing the basis of partnership assets.
Sufficient reasons for approving a request involve a change in circumstances that makes the election administratively burdensome. Examples include a significant increase in the partnership’s assets, a change in the character of those assets, or an increased frequency of partner retirements or transfers of partnership interests.
Preparing the Revocation Request
To request a revocation, a partnership must use Form 15254, Request for Section 754 Revocation. This form serves as the official application to the IRS.
The core of the form is the requirement to provide a detailed explanation of the reasons for seeking the revocation. The partnership must describe the circumstances that have made the Section 754 election an administrative burden. This explanation is important, as the IRS will evaluate these reasons to determine whether to grant approval.
How to File the Revocation Request
The process for filing Form 15254 is distinct from the annual tax return filing, as the form must be filed separately. It must be submitted no later than 30 days after the close of the partnership taxable year for which the revocation is intended to take effect.
After the request is filed, the IRS will review the application and the stated reasons. The IRS will issue a letter either approving or denying the request. If approved, the revocation becomes effective for the taxable year specified in the application and remains in effect for all subsequent years. Should circumstances change in the future, the partnership can make a new Section 754 election by filing it with the tax return for the year it is to become effective.