A founder dies. His heirs inherit a stepped-up basis worth millions. Most partnerships make them wait until exit to use it.
That waiting is almost always a choice nobody realized they were making. The step-up itself is automatic and valuable, and the heirs own it the moment the founder passes. Whether it goes to work during the hold or sits frozen until the building sells comes down to a single election that often never gets filed. The difference between those two outcomes can be years of depreciation deductions the heirs are entitled to and never see.
What happens to a partner's basis automatically at death?
When a partner dies, their partnership interest steps up to fair-market value automatically under Section 1014(a). The heirs' outside basis — their basis in the partnership interest itself — resets to today's number on its own: no election, no filing, no CPA action required. That step-up is theirs no matter what anyone does.
In plain English, the IRS treats the heirs as if they bought the partnership interest at its current value on the date of death. The decades of appreciation and depreciation that happened on the founder's watch get wiped clean from the heirs' perspective. Their starting line moves up to where the property actually sits today. So far this is all good news, and it's the part most people assume is the whole story.
Why doesn't the step-up reach the partnership's assets?
Because it lands only at the partner level — on the heirs' interest in the partnership, not on the property itself. Inside the partnership the assets don't move: the building, the improvements, and the depreciable property keep their original cost basis and keep depreciating off it exactly as they did before the partner died. The step-up is stranded one level up.
With no Section 754 election on file, that disconnect just persists. The heirs report income on their K-1 as if the partner never died — owning a slice of the partnership worth millions in today's dollars while the books still treat that slice like it's 2009. The outside basis stepped up. The inside basis didn't. Nobody made it move.
Does a 754 election reduce total tax, or just change the timing?
Just the timing. The election does not shrink the heirs' gain at exit — the stepped-up outside basis already absorbs that, so their gain comes out smaller at sale whether or not the election was ever filed. The finish line doesn't move. What moves is when the heirs get to use the step-up.
Without the election, the full benefit waits at the back of the deal and shows up only as reduced gain at sale. With the election, part of that same benefit comes forward and goes to work during the hold. Same total benefit, two completely different schedules for collecting it.
Same total benefit, two completely different schedules for collecting it.
What does filing a Section 754 election actually unlock?
It triggers a Section 743(b) basis adjustment for the heirs alone. Their piece of the building steps up inside the partnership and starts throwing off depreciation now, in the current year, against the income they're reporting — the same inside-basis mechanism that unlocks depreciation on a partner exit. The adjustment belongs only to the heirs, not to the other partners, so it tracks their inherited step-up precisely.
Picture a $4M property that's been depreciated down to $1M of remaining basis. That's a $3M step-up the heirs already own through their stepped-up outside basis. Skip the election and that $3M stays locked inside the partnership until exit, doing nothing for the heirs year to year. File it and the $3M starts generating fresh depreciation deductions that cut the heirs' tax bill every year of the hold — years before the building ever sells. The step-up goes to work during the hold instead of waiting in line behind a sale that might be a decade away.
What two steps put the inherited step-up to work?
Two things, and both get skipped constantly. First, a Section 754 election filed for the year of death. Second, a CPA who actually runs the 743(b) math and tracks the adjustment partner by partner through every remaining year of the hold, because the step-up belongs to the heirs alone. Neither move is exotic — both routinely never happen, usually because the people on the cap table assumed the automatic outside-basis step-up was the entire benefit.
The step-up is already theirs. The only question is whether it works for them now or sits frozen until the sale. Most partnerships just leave it frozen.