A buy-out of a partner's interest creates new depreciable basis when a §754 election is in effect: §743(b) adjusts the buyer's basis in partnership property by the excess of outside basis over the buyer's share of inside basis, allocated under §755 (a redemption falls under §734(b) instead). Cost segregation then decides how much lands in 5-, 7- and 15-year property.
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 provider 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
A late §754 election generally has an automatic 12-month extension from its due date under Treas. Reg. §301.9100-2(a)(2)(vi) if that section's conditions are met; after that, relief is by request under §301.9100-3, which the IRS decides case by case. The partnership's CPA makes that filing, not the cost segregation provider. 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 and Treas. Reg. §1.755-1(b) then allocate the adjustment among the partnership's assets, and there is no land-first ordering: the adjustment is split first between the capital-gain class (capital assets and §1231 property, which includes the land and the building) and the ordinary-income class (which includes the potential §1245 recapture in previously depreciated personal property, treated as a separate asset), and then among the items in each class by the gain or loss the transferee would be allocated if the partnership sold all of its property for cash at fair market value, with any difference between the capital-gain class's total gain and the adjustment allocated to that class spread across its items in proportion to fair market value (Treas. Reg. §1.755-1(b)(3)(ii)). Land takes the share its own built-in gain earns it, and that share is never depreciable; the share allocated to depreciable property is 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 identifies the separate assets inside the building's single line item: the 5- and 7-year personal property, the 15-year land improvements, and the 39-year shell (27.5-year for residential rental property). That inventory is what lets the Treas. Reg. §1.755-1 allocation run item by item, because each item's share of the adjustment depends on its own fair market value at the transfer date and the transferee's share of the partnership's adjusted basis in it. The result is not the study's property-level percentages applied pro rata: short-life components the partnership has already depreciated heavily carry more built-in gain, so they can draw a larger share of the adjustment than their share of the original cost. The transferee's new depreciable basis is then split across the recovery periods by that item-level allocation.
The mechanical output is a §743(b) supplement to the study's exhibit set: a table showing the total adjustment, the item-by-item allocation under §755 and Treas. Reg. §1.755-1, 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), Treas. Reg. §1.168(k)-2(b)(3)(iv)(D) treats the §743(b) basis increase as a used-property acquisition, eligible for bonus depreciation on the portion allocated to bonus-eligible property (broadly, 5-, 7-, and 15-year property), only when the buyer had no depreciable interest in that portion of the property before the transfer and the purchase meets the §179(d)(2) requirements that Treas. Reg. §1.168(k)-2(b)(3)(iii)(A)(2) incorporates, including that the interest is not bought from a related person (relatedness is tested between the transferor and the transferee of the interest, §1.168(k)-2(b)(3)(iv)(D)(2)). Under the One Big Beautiful Bill Act (OBBBA), bonus is permanent at 100% when the written contract to buy the interest became binding after January 19, 2025 — IRS Notice 2026-11 confirmed the acquired-date test turns on the binding contract, not the closing date. When it became binding on or before January 19, 2025, the TCJA phase-down applies by the year of the transfer: 80% in 2023, 60% in 2024, 40% in 2025, 20% in 2026, and 0% after that.
For an inheritance-triggered adjustment (§1014 step-up flowing through §743(b) after a partner's death), the basis increase does not qualify for bonus depreciation, because the heir’s basis in the interest is determined under §1014, and §179(d)(2)(C)(ii), which the used-property rules apply to a §743(b) adjustment, excludes a basis determined under §1014 (Treas. Reg. §1.168(k)-2(b)(3)(vii)(P), Example 16). 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. Two OZ-specific questions sit next to the step-up: whether an OZ investor has the basis to use the deductions at all, which is the Opportunity Zone zero-basis problem under §1400Z-2, and where in the deal timeline the study belongs, which is the cost segregation timing playbook for OZ sponsors. 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, if the conditions of Treas. Reg. §301.9100-2(a)(2)(vi) are met, within the automatic 12-month extension from its due date; after that, relief is by request under §301.9100-3, which the IRS decides case by case). Without the election, there is no §743(b) adjustment to allocate.
- Trigger event date(s) — the date the buy-out contract became binding 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, its component inventory and costs can be reused as the starting point, but the §743(b) allocation is still run item by item at fair market value as of the transfer date, not by re-applying the study's percentages. When the partnership's real estate sits under a lease rather than fee title, the lease documents come into intake too — see cost segregation and depreciation on a municipal OZ ground lease and how Opportunity Zone leased-property structuring is drafted around cost segregation.
- Basis inputs — either the partnership's Form 1065 + K-1s (the cost segregation provider 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. Those assumed liabilities are the same figures a lender reads in why debt basis changes depreciation capacity in an Opportunity Zone deal.
Prior-Year Twist — Late Election, Form 3115 or Amended Return
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), it depends on what went wrong. If the §754 election itself was missed, the first question is late-election relief: a late §754 election generally has an automatic 12-month extension from its due date under Treas. Reg. §301.9100-2(a)(2)(vi) if that section's conditions are met; after that, relief is by request under §301.9100-3, which the IRS decides case by case. If the election was in effect and the §743(b) adjustment was determined but its depreciation was claimed too slowly or not at all, the partnership's tax adviser decides whether a change in depreciation method on Form 3115 under section 6.01 of Rev. Proc. 2025-23, or an amended return or administrative adjustment request, is the right route on the partnership's own facts. The Form 3115 mechanic itself is the one look-back catch-up cost segregation studies use, and the cost segregation provider supplies the underlying numbers whichever route the adviser chooses.
For the adviser’s view of the same basis question inside a fund, see QOF debt basis and cost segregation planning for CPAs.
Related: Does Depreciation Restart When You Transfer a Rental to an LLC? Cost Segregation for 2026
Frequently Asked Questions
Do we need a §754 election in place before the transfer to get a cost segregation benefit?
A §754 election is needed, but it does not have to be in place before the transfer: without one, §743(b) does not create an inside-basis adjustment for a cost segregation study to allocate, and the partnership can make it on its timely filed Form 1065, including extensions, for the year of the transfer (Treas. Reg. §1.754-1(b)). A late §754 election generally has an automatic 12-month extension from its due date under Treas. Reg. §301.9100-2(a)(2)(vi) if that section's conditions are met; after that, relief is by request under §301.9100-3, which the IRS decides case by case. The partnership's CPA makes that filing, and until the election is in place 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 a purchase-triggered adjustment when the written contract to buy the interest became binding after January 19, 2025 (100% under OBBBA per IRS Notice 2026-11), the buyer had no prior depreciable interest in that portion of the property, and the seller is not a related person; no for an inheritance-triggered adjustment, because the heir’s basis in the interest is determined under §1014, and §179(d)(2)(C)(ii), which the used-property rules apply to a §743(b) adjustment, excludes a basis determined under §1014 (Treas. Reg. §1.168(k)-2(b)(3)(vii)(P), Example 16). 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 for what it identifies: the separate 5-, 7-, 15-, 27.5- and 39-year assets and their costs. It cannot be reused as a set of percentages, because Treas. Reg. §1.755-1 allocates the §743(b) adjustment item by item by each item's built-in gain at fair market value on the transfer date (with any remainder in the capital-gain class spread in proportion to fair market value), so the supplement needs fair market values as of that date and the partnership's adjusted basis in each item. If no prior study exists, a property-level cost segregation study is done first and the §743(b) supplement is produced from its inventory.
What if the transfer happened in a prior tax year and nothing was done at the time?
It depends on what went wrong. If the §754 election itself was missed, the first question is late-election relief: a late §754 election generally has an automatic 12-month extension from its due date under Treas. Reg. §301.9100-2(a)(2)(vi) if that section's conditions are met; after that, relief is by request under §301.9100-3, which the IRS decides case by case. If the election was in effect and the §743(b) adjustment was determined but its depreciation was claimed too slowly or not at all, the partnership's tax adviser decides whether a change in depreciation method on Form 3115 under section 6.01 of Rev. Proc. 2025-23, or an amended return or administrative adjustment request, is the right route on the partnership's own facts. Whichever route applies, the cost segregation provider 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- and 7-year property, §1250 ordinary recapture of depreciation taken above straight-line on 15-year land improvements held more than one year, and unrecaptured §1250 gain (capped at 25%) on the shell and the rest of the land-improvement depreciation. 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, on a qualifying investment held ten years or more, an investor who sells the QOF interest and makes the §1400Z-2(c) FMV basis election removes that recapture on the interest; a sale of the property by the fund is a different transaction with a different election, and whether a purchased interest is a qualifying investment at all is covered in §754 inside an Opportunity Zone fund.
Getting Started
How long a §754 / §743(b) cost segregation engagement takes depends on whether a prior property-level study exists and on when the CPA supplies the §754 election status and the §743(b) adjustment amounts, and the work starts once we receive complete documents. 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, bonus depreciation on the eligible slice (100% for an adjustment from a purchase whose contract became binding after January 19, 2025, and the phase-down rate for an earlier contract) is claimed on the partnership return for the tax year of the transfer, so the §743(b) supplement belongs in hand before that return is filed.
Start your cost segregation study, or reach out through our Opportunity Zone cost segregation page if the partnership is a QOF or holds property inside an OZ tract. To compare providers on method and published terms, see the best cost segregation companies comparison.
