Post-TEFRA cost basis in a partnership is the individualized basis a new partner receives in their share of the partnership’s underlying assets after a Section 743(b) adjustment. When you buy a partnership interest or inherit one, you typically pay or are credited with a value that reflects fair market value, but the partnership’s books still carry its assets at their original cost. The 743(b) adjustment closes that gap for you alone, giving you an asset-level basis that matches what your interest actually cost. It runs through a partnership-level election, a specific formula, and an allocation across the partnership’s assets.
Two Basis Numbers, Not One
Partnership taxation tracks two separate basis figures, and the adjustment only makes sense once both are clear.
Your outside basis is the basis in the partnership interest itself. For a buyer, it starts at the purchase price plus any partnership liabilities assumed. It goes up with additional contributions and allocations of income, and down with distributions and allocated losses.
Inside basis is the partnership’s own adjusted basis in the assets it holds. That is the figure the partnership uses for depreciation, amortization, and gain or loss when it sells property. Each partner has a proportionate share of it.
In theory, your outside basis and your share of inside basis should match. They diverge the moment an interest changes hands at a price that differs from the seller’s share of inside basis, which is almost always the case when the partnership holds appreciated or depreciated property.
Why the Disparity Matters
Say a partnership owns real estate it bought for $1,000,000 that is now worth $2,000,000. A 50% partner sells their interest to you for $1,000,000. Your outside basis is $1,000,000. But the partnership’s books still show the real estate at $1,000,000, so your 50% share of inside basis is only $500,000.
Without an adjustment, you would take depreciation on that $500,000 figure and recognize $500,000 of built-in gain if the partnership sold the property tomorrow at its current value. You already paid for that appreciation. Taxing it again to you would be economically wrong. The Section 743(b) adjustment gives you an extra $500,000 of basis in the underlying assets, and only you see the benefit.
When the Adjustment Kicks In
Two paths lead to a 743(b) adjustment: an elective one and a mandatory one.
The Section 754 Election
The adjustment does not happen on its own. The partnership must have a Section 754 election in effect for the year of the transfer.1Office of the Law Revision Counsel. 26 USC 754 – Manner of Electing Optional Adjustment to Basis of Partnership Property This is a partnership-level decision. A buyer cannot make it unilaterally. It is filed by attaching a statement to the partnership’s timely filed Form 1065 for the tax year of the transfer.
Once made, the election is permanent. It applies to all future transfers of partnership interests and all distributions of partnership property. That consistency is helpful, but it also commits the partnership to calculating adjustments for every future transfer, which can be a real administrative load when ownership turns over often.
A partnership that misses the filing deadline can request an extension under the Section 9100 regulations by showing it acted reasonably and in good faith and that granting relief will not harm the government’s interests.2Internal Revenue Service. Private Letter Ruling 202045004 The window is narrow, so a missed election is worth a quick call to a tax professional.
Mandatory Adjustment for Substantial Built-In Loss
Even without an election, the adjustment is mandatory when the partnership has a “substantial built-in loss” immediately after the transfer. The rule was enacted by the American Jobs Creation Act of 2004 and expanded by the Tax Cuts and Jobs Act of 2017. It is triggered when either condition is met:3Office of the Law Revision Counsel. 26 USC 743 – Special Rules Where Section 754 Election or Substantial Built-in Loss
- The partnership’s total inside basis exceeds the fair market value of its property by more than $250,000.
- The new partner would be allocated a loss of more than $250,000 if the partnership sold all its assets at fair market value immediately after the transfer.
The second test came in with TCJA. It catches transfers where the partnership-wide numbers look fine but the incoming partner’s specific share carries an outsized built-in loss, preventing a buyer from acquiring an interest cheaply and then claiming inflated losses against other income.4Internal Revenue Service. TCJA – Modification to Substantial Built-in Loss Rules under IRC 743(d)
How the Adjustment Is Calculated
The formula is short. Subtract the transferee’s share of the partnership’s inside basis from the transferee’s outside basis. The result is the Section 743(b) adjustment.3Office of the Law Revision Counsel. 26 USC 743 – Special Rules Where Section 754 Election or Substantial Built-in Loss
In the real estate example above, you paid $1,000,000 for a 50% interest and your share of inside basis is $500,000. The adjustment is $1,000,000 minus $500,000, or a positive $500,000. That $500,000 increase applies only to your share of the assets. Nothing changes for the other partners.
The adjustment can go the other way. If you paid $300,000 for the same 50% interest, perhaps because of significant liabilities or operating trouble, the adjustment would be $300,000 minus $500,000, or negative $200,000. A negative adjustment shrinks your share of asset basis, cuts your depreciation, and increases the gain you will report on a future sale.
One wrinkle worth flagging. If the partnership holds property that a partner originally contributed rather than the partnership having bought it, Section 704(c) requires the partnership to track the built-in gain or loss on that property from the date of contribution.5eCFR. 26 CFR 1.704-3 – Contributed Property The transferee steps into the seller’s shoes for that item, so the share of inside basis used in the formula is not a plain pro-rata slice. Contributed property distorts the calculation if it is ignored.
Spreading the Adjustment Across the Assets
The total adjustment is only half the exercise. Under Section 755, the partnership then allocates it among individual assets, working to close the gap between each asset’s tax basis and its fair market value.6Office of the Law Revision Counsel. 26 USC 755 – Rules for Allocation of Basis
The regulations first sort assets into two classes. One holds capital assets and property used in the business: real estate, equipment, goodwill. The other holds everything that would produce ordinary income on sale, mainly inventory and accounts receivable.7eCFR. 26 CFR 1.755-1 – Rules for Allocation of Basis The total adjustment is split between the two classes based on the unrealized gain or loss in each.
Within each class, positive adjustments go to appreciated assets and negative adjustments go to depreciated assets. No allocation can push an asset above its fair market value or below zero.7eCFR. 26 CFR 1.755-1 – Rules for Allocation of Basis
If you pay more for an interest than the fair market value of the partnership’s tangible assets, the excess typically lands on goodwill. Section 197 requires any adjustment allocated to goodwill or other recognized intangibles to be amortized ratably over 15 years starting in the month of the transfer.8Office of the Law Revision Counsel. 26 USC 197 – Amortization of Goodwill and Certain Other Intangibles That is a slow recovery for a large chunk of basis, and it matters most in service firms and professional practices where goodwill dominates the purchase price.
How You Actually See the Benefit
A positive adjustment allocated to depreciable property is treated as if you bought that asset new at the time of the transfer. It gets a fresh recovery period under the applicable depreciation rules, independent of the schedule the partnership is already running.9eCFR. 26 CFR 1.743-1 – Optional Adjustment to Basis of Partnership Property If the partnership has been depreciating 7-year equipment for five years, your adjustment on that equipment starts a new 7-year clock.
The adjustment may qualify for bonus depreciation, potentially allowing a large first-year deduction. Eligibility requires that you did not previously hold a depreciable interest in the same property, the transfer was a purchase rather than a gift or inheritance, and you and the seller are not related parties. Bonus depreciation rates have shifted with legislative changes, so the applicable percentage depends on the year of the transfer.
The extra depreciation or amortization is added to your distributive share of the partnership’s depreciation for the year and reported on your Schedule K-1. It affects your return only, not the other partners’.9eCFR. 26 CFR 1.743-1 – Optional Adjustment to Basis of Partnership Property10Internal Revenue Service. Partners Instructions for Schedule K-1 (Form 1065) (2025)
You are also the one who has to trigger the process. As the transferee, you must notify the partnership of the transfer in writing within 30 days of a purchase. The notice must include names and taxpayer identification numbers of both parties, the date of the transfer, any liabilities assumed, and the amount paid.9eCFR. 26 CFR 1.743-1 – Optional Adjustment to Basis of Partnership Property Without that information, the partnership cannot run the calculation.
Transfers at Death
Section 743(b) is not limited to sales. It also applies when a partnership interest passes because a partner dies.3Office of the Law Revision Counsel. 26 USC 743 – Special Rules Where Section 754 Election or Substantial Built-in Loss Under Section 1014, the deceased partner’s interest generally gets a stepped-up basis equal to fair market value on the date of death. That new outside basis creates the same disparity a purchase does, and 743(b) resolves it the same way.
The difference is timing. The notification window for a death transfer runs one year from the date of death rather than 30 days, recognizing that estate administration takes time.9eCFR. 26 CFR 1.743-1 – Optional Adjustment to Basis of Partnership Property The partnership still needs a 754 election in effect, or must make one for the year of death. Executors and heirs who skip this step lose a real tax benefit, because the stepped-up basis at the partnership-interest level does nothing for depreciation on the underlying assets without a matching 743(b) adjustment.
What the Adjustment Does Not Do
The 743(b) adjustment does not change the character of income. When the partnership holds “hot assets” under Section 751 (unrealized receivables, inventory, property carrying depreciation recapture), any adjustment allocated to those assets keeps its ordinary income character. If the partnership sold them, your share of the gain or loss would be ordinary, adjustment or no adjustment.
Recapture items under Sections 1245 and 1250 carry a zero basis for the recapture calculation, and as transferee you inherit the seller’s exposure. Part of what you paid for the interest will come back as ordinary income rather than capital gain, even with the adjustment in place. That is worth modeling before closing when buying into a partnership with heavily depreciated equipment or large receivables.