This article is educational and is not legal or tax advice. Partnership basis adjustments are fact-specific — confirm any position with your tax advisor before you act.
The Overlooked Cost Segregation Opportunity Inside a Partnership Buy-Out
When one partner in a real-estate partnership buys another partner out — or when an estate inherits a partnership interest under §1014 — the transferee ends up with an outside basis (their basis in the partnership interest) that is very different from their share of the partnership's inside basis (the partnership's basis in its assets). Left alone, that gap does nothing. Add a §754 election and the same event triggers a §743(b) basis adjustment that quietly creates new depreciable basis for the incoming partner. A cost segregation study on the underlying real estate then decides how fast that new basis is recovered.
This is one of the highest-leverage opportunities in partnership tax, and it is missed constantly because the mechanic sits between two specialties: the CPA runs the §754 / §743(b) analysis, the cost segregation engineer runs the recovery-period allocation, and the paperwork rarely arrives on the same desk. This post walks the mechanic end to end and shows exactly where the cost segregation study plugs in — including the split between purchase-triggered adjustments (bonus-eligible under §168(k)) and inheritance-triggered adjustments (not bonus-eligible).
What §754 Actually Does
A partnership makes the §754 election on its Form 1065 to permit inside-basis adjustments when a partnership interest is transferred (§743(b)) or when a distribution is made (§734(b)). The election is generally irrevocable and applies to every subsequent transfer, so it is a decision made once with future consequences. A partnership without the election in place at the time of a transfer sees no §743(b) adjustment — the transferee's outside basis is stepped up, but the inside basis stays exactly where it was. That gap sits on the transferee's schedule and does nothing.
Under §743(b), if an election under §754 is in effect, the transferee partner takes an adjustment to the basis of partnership property equal to the excess of the transferee's outside basis over the transferee's share of the adjusted basis of partnership property. — Framework of IRC §743(b) and §754
Late §754 elections are possible in some circumstances via an automatic-consent revenue procedure (Rev. Proc. 2020-23 and its successors) — this is the CPA's filing to make, not the cost segregation engineer's. But the sequencing matters: without the election, no §743(b) adjustment, no new depreciable basis, no cost segregation opportunity.
The §743(b) Adjustment, Allocated Under §755
Once §754 is in place, §743(b) computes the transferee's basis adjustment as the difference between their outside basis (what they paid, or the §1014 date-of-death fair-market value for an inherited interest) and their share of the partnership's inside basis in its assets. Positive adjustments (typical in appreciated real estate) create new depreciable basis for the transferee. §755 then allocates the adjustment among partnership assets — land first (never depreciable, but takes its share), then depreciable improvements, then personal property, then any receivables or other items. The land portion is inert from a depreciation standpoint; the depreciable-improvements portion is exactly where a cost segregation study earns its keep.
How a Cost Segregation Study Applies to the §743(b) Step-Up
A cost segregation study of the underlying real property produces the ratio of the property's depreciable basis that lands in each recovery period — typical splits under IRS ATG Chapter 4 are 5-year personal property (roughly 15–25% of a commercial property, higher for restaurants or self-storage), 15-year land improvements (5–15%), and 39-year (residential rental: 27.5-year) for the shell. Once you have those percentages for the property as a whole, you apply them to the depreciable-improvements slice of the §743(b) adjustment. The transferee's new depreciable basis is now split across the same buckets.
The mechanical output is a §743(b) supplement to the study's exhibit set: a table showing the total adjustment, the land-vs-improvements split under §755, and the per-bucket dollar amount that flows into the transferee's depreciation schedule. That table is what the CPA drops into the K-1 attachment under §754 so the deductions land on the transferee's personal return.
Purchase vs Inheritance: The Bonus Depreciation Split That Matters
The §743(b) adjustment itself does not depend on how the transfer happened — a purchase and an inheritance both trigger it once §754 is in place. But bonus depreciation under §168(k) treats the two paths very differently, and the split is where large dollars move.
For a purchase-triggered adjustment (one partner buys another out), the §743(b) step-up is treated as a separately-depreciable asset acquisition per Treas. Reg. §1.168(k)-2(b)(3)(iv)(D). Bonus depreciation applies to the portion allocated to bonus-eligible property (broadly, 5-, 7-, and 15-year property). Under the One Big Beautiful Bill Act (OBBBA), bonus is permanent at 100% for property with a written binding contract date after January 19, 2025 — IRS Notice 2026-11 confirmed the acquired-date test turns on the contract date, not the closing date. Contract dates before January 20, 2025 land on the TCJA phase-down (80% for 2023, 60% for 2024, 40% for pre-1/20/2025 in 2025).
For an inheritance-triggered adjustment (§1014 step-up flowing through §743(b) after a partner's death), the transferee's slice is treated as used property acquired from a related person under Treas. Reg. §1.168(k)-2(b)(3)(iv)(C) and does not qualify for bonus depreciation. Straight-line MACRS still applies on the newly-created basis, and a cost segregation study still accelerates recovery relative to depreciating everything as 39-year property — the benefit just does not include the front-loaded Year-1 bonus.
Practically, an estate that both inherited some slice of a partnership and then bought other partners out (a common family-office pattern) has two §743(b) adjustments running in parallel, one bonus-eligible and one not. They must be tracked and computed separately so the cost segregation deliverable can attach bonus to the right slice and only the right slice.
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Where This Fits Alongside Opportunity Zones
The interaction between §754 and Opportunity Zones (§1400Z-2) has its own nuances — a Qualified Opportunity Fund is a partnership for tax purposes, and interest transfers inside a QOF trigger §743(b) exactly the same way, but §1400Z-2's own basis rules interact with the step-up in ways that reward some scenarios and neutralise others. We covered that specifically in §754 Inside an Opportunity Zone Fund. For a straightforward non-OZ real-estate partnership, this post is the primer; for OZ funds specifically, read the two together.
The Facts a §754 Cost Segregation Engagement Needs at Intake
A clean §743(b) cost segregation deliverable turns on six inputs, and gathering them up front is what keeps the engagement fast:
- §754 election status — is the election already on the partnership's Form 1065? If not, the CPA files it (timely, or via late-consent automatic revenue procedure). Without the election, there is no §743(b) adjustment to allocate.
- Trigger event date(s) — buy-out contract date drives the bonus depreciation rate on the purchase-triggered slice; decedent's date of death drives the §1014 fair-market value on the inherited slice.
- Partnership tax year — calendar or fiscal; drives when the deduction lands.
- Underlying real estate — property type, address, acquisition history, whether a prior cost segregation study already exists. If it does, the same recovery-period percentages carry into the §743(b) allocation without a fresh property-level study.
- Basis inputs — either the partnership's Form 1065 + K-1s (the engineer derives inside and outside basis) or the CPA hands over the §743(b) adjustment amount directly.
- Consideration structure — purchase price and any assumed liabilities for a purchase-triggered adjustment; estate valuation records for an inheritance-triggered one.
Prior-Year Twist — Form 3115 and §481(a)
If the transfer happened in a prior tax year and the partnership's return has already been filed without picking up the §743(b) adjustment (or with an incorrect allocation), the fix is a Form 3115 accounting-method change with a §481(a) catch-up in the current year — the same mechanic that lets look-back catch-up cost segregation studies claim years of missed depreciation without amending returns. The §754 amendment path applies to allocation errors; the 3115 path applies when the mechanic was missed entirely. Which one applies is the CPA's call, but the cost segregation engineer supplies the underlying numbers either way.
Frequently Asked Questions
Do we need a §754 election in place before the transfer to get a cost segregation benefit?
Yes. Without a §754 election, §743(b) does not create an inside-basis adjustment, and there is no new depreciable basis for the cost segregation study to allocate. Late §754 elections are possible via automatic-consent revenue procedures (Rev. Proc. 2020-23 and successors), so a partnership that missed the election can still catch up — but this is the CPA's filing, and until it lands the cost segregation opportunity is dormant. Confirm the election status before signing an engagement letter for a §754 cost segregation study.
Can bonus depreciation apply to the §743(b) step-up?
Yes for purchase-triggered adjustments with a contract date after January 19, 2025 (100% under OBBBA per IRS Notice 2026-11); no for inheritance-triggered adjustments (used property acquired from a decedent, excluded from bonus per Treas. Reg. §1.168(k)-2(b)(3)(iv)(C)). An estate that both inherited a partnership interest and later bought other partners out has both slices, and each is treated separately for bonus purposes — one qualifies, the other does not. This is exactly why the §743(b) supplement in the cost segregation deliverable computes the two adjustments as separate line items.
Does the cost segregation study need to be done from scratch, or can an existing one be reused?
An existing property-level cost segregation study can be reused. The recovery-period percentages (5-year, 7-year, 15-year, 27.5-year, 39-year) are properties of the real estate itself, and they do not change because a partnership interest changed hands. The §743(b) supplement applies the existing percentages to the new basis adjustment. If no prior study exists, a fresh property-level cost segregation study is done first and the §743(b) supplement is produced from that study's output.
What if the transfer happened in a prior tax year and nothing was done at the time?
The fix is a Form 3115 accounting-method change with a §481(a) catch-up in the current year — the same mechanic that supports look-back cost segregation studies. The cumulative depreciation the transferee should have taken from the transfer date forward is computed, netted against what was actually taken (typically nothing), and the difference flows through as a current-year adjustment. No amended returns are needed. The 3115 is the CPA's filing; the cost segregation engineer supplies the underlying schedule of what the depreciation should have been each year.
Does a §743(b) cost segregation study trigger recapture at exit?
The same recapture rules that apply to any cost segregation study apply here: §1245 ordinary-income recapture on the short-life 5-, 7-, and 15-year property, unrecaptured §1250 gain (capped at 25%) on the shell. Because the §743(b) step-up creates new depreciable basis rather than resetting the property's own basis, the recapture at exit sits with the transferee whose §743(b) adjustment generated it. Inside an Opportunity Zone fund held ten years or more, the §1400Z-2(c) FMV basis election erases both layers of recapture on the QOF interest — one of the reasons the §754 mechanic pairs so well with OZ investing.
Getting Started
A §754 / §743(b) cost segregation engagement typically runs 3–6 weeks depending on whether a prior property-level study exists and how quickly the CPA can supply the §754 election status and the §743(b) adjustment amounts. If a partnership transfer happened this year — a buy-out, an inheritance, an estate distribution — and the underlying real estate has never been cost-segregated, the window to lock in Year-1 bonus depreciation on the eligible slice closes with the tax year.
Start with the qualifier to size the opportunity in five minutes, or reach out through our Opportunity Zone cost segregation page if the partnership is a QOF or holds property inside an OZ tract. If you want to see how we compare against the market on turnaround and citation quality, the best-of comparison is here.
