When a partner wants out of an LLC, the exit structure can unlock additional depreciation. Most operators don't realize that until it's too late to use it.
The reason it's easy to miss is that the two paths an exit can take look almost identical on the surface. Same economics. Same wire transfer. Same cap table outcome. The structural decision happens in a corner of the deal that doesn't affect the price, doesn't change the timing, and doesn't show up in the LP communication. But it can produce wildly different tax results for the partners who stay in the deal and for the partner who comes in to replace the one who left.
There are generally two ways a partner exit plays out, and the choice between them is where the depreciation outcome gets decided.
Scenario one: the redemption
The first scenario is a redemption. The LLC itself buys out the exiting member. The partnership uses its own cash, or proceeds from a refinance, or a fresh capital call from the remaining partners, to make a liquidating distribution to the partner who's leaving. That distribution is typically governed by the operating agreement. The exiting partner's interest is retired. The remaining partners' interests proportionately expand to fill the space.
If the partnership has a Section 754 election in place, that redemption can trigger a Section 734(b) basis adjustment. Plain English: when the redemption produces taxable gain for the exiting partner (because the cash they received exceeded their outside basis), the partnership can step up the inside basis of its assets by a corresponding amount. The remaining partners depreciate that step-up going forward.
The result is straightforward to describe and meaningful in practice. The partners who stayed in the deal may unlock additional depreciation they otherwise wouldn't have had. The property didn't change. The deal didn't change. The economics didn't change. But the inside basis of the underlying assets just went up, and so did the depreciation pool the remaining partners get to draw from.
Scenario two: the sale
The second scenario is a sale. Instead of the LLC redeeming the exiting partner, another member or an outside party buys their interest directly. The buyer pays fair market value. The exiting partner walks. The buyer steps into the cap table where the exiting partner used to sit.
The buyer's outside basis increases automatically to whatever they paid. That part is just basic tax mechanics. What's not automatic is whether the inside basis of the partnership's assets keeps up with the outside basis the buyer just established.
Without a Section 754 election, that higher purchase price does not translate into additional depreciation. The buyer paid market value, which presumably reflects appreciation in the underlying assets since the partnership acquired them. But the partnership's inside basis stays where it was. The buyer is depreciating the same allocated share of the same inside basis the exiting partner was depreciating. They paid more. They get the same write-offs. The gap between what they paid and what they get to depreciate sits in their outside basis, useful eventually but doing nothing for them in the meantime.
With a 754 election in place, the buyer can receive a Section 743(b) basis adjustment. The partnership steps up the buyer's share of the inside basis of its assets to reflect what the buyer actually paid. The buyer then depreciates the stepped-up share going forward, in proportion to the gain that would have been allocated to them on a hypothetical sale of the partnership's assets.
The election unlocks a benefit. The absence of the election strands one.
Does the redemption-versus-sale choice still matter?
There's a tempting question to ask here, which is whether the choice between redemption and sale matters once a 754 election is in place. The economics are often indistinguishable. The same partner is leaving. The same dollar amount is changing hands. The remaining partners end up in the same proportional position.
The answer is that the structural choice still matters, because the two paths trigger different basis adjustment mechanics with different downstream effects. A 734(b) adjustment from a redemption affects the inside basis of partnership assets at the partnership level and flows to all remaining partners proportionately. A 743(b) adjustment from a sale affects only the buyer's share of the inside basis and is tracked at the partner level. The accounting is different. The compliance burden is different. The way subsequent transactions interact with the adjustment is different.
Practically, redemption tends to be cleaner when the partnership has the cash to fund it and the remaining partners want the depreciation benefit spread proportionately. Sale tends to be cleaner when an outside buyer is willing to pay full value and the remaining partners don't want to bear the cash outlay. Neither is universally better. The right path depends on who has the cash, who wants the deductions, and what the rest of the deal looks like.
The piece that gets missed: the 754 election itself
The piece that gets missed in both cases is the 754 election itself. Without it, neither path produces a basis step-up. The buyer in a sale gets nothing extra. The remaining partners in a redemption get nothing extra. The election is the door through which the depreciation benefits enter. If the door is closed, the structural choice between redemption and sale is mostly cosmetic from a tax perspective.
The election has to either already be in place or be made affirmatively for the year the exit happens. Once made, it generally applies to that year and all future years and can only be revoked with IRS consent and for cause. Most operator-driven LLCs benefit from the election. There are edge cases where the ongoing compliance burden or the risk of downward adjustments tips the math the other way, but for most appreciated real estate partnerships, the election is the cheap part of getting the structure right.
The cost segregation interaction
There's a second piece worth flagging, which is the cost segregation interaction. When the partnership's underlying assets have been cost segregated, the basis step-up from a 734(b) or 743(b) adjustment generally needs to be allocated across the same asset categories. That means the depreciation benefit isn't a single number applied to a 39-year asset. Portions of it can flow to shorter-lived components, accelerating the benefit substantially. If the partnership has done a cost seg study, the step-up is worth more than the headline number suggests. If it hasn't, that may be an additional decision worth modeling alongside the exit.
These exits look simple on paper. In reality, the tax outcome hinges on three things. Whether the exit is structured as a redemption or a sale. Whether a Section 754 election is in place before the exit happens. Whether the underlying asset basis is set up to flow the resulting step-up through depreciation efficiently.
The partner asking to leave isn't aware of any of this. They want to know what they're getting paid and when. The partner staying in the deal, or buying the exiting interest, is the one whose tax outcome is being decided. Whichever role you're playing, the decision worth making before the wire goes out is which structure produces the depreciation result you actually want.
Same exit. Same price. Two different tax returns. The structure is what picks which one.