Section 754 Elections on Form 1065: Making Valid Elections...

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Section 754 Elections on Form 1065: Making Valid Elections, Seeking Relief For Missed or Invalid ElectionsTUESDAY, FEBRUARY 2, 2021, 1:00-2:50 pm Eastern

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February 2, 2021

Section 754 Elections on Form 1065: Making Valid Elections, Seeking Relief For Missed or Invalid Elections

Heath Standorf, CPA

Senior Manager of Tax Services

Berkowitz Pollack Brant

[email protected]

Pamela A. Fuller, Esq.

Counsel (Tax, M&A, International)

Zahn Law Group

[email protected]

Of Counsel (Tax, M&A, International)

Tully Rinckey PLLC

[email protected]

Notice

ANY TAX ADVICE IN THIS COMMUNICATION IS NOT INTENDED OR WRITTEN BY THE SPEAKERS’ FIRMS TO BE USED, AND CANNOT BE USED, BY A CLIENT OR ANY OTHER PERSON OR ENTITY FOR THE PURPOSE OF (i) AVOIDING PENALTIES THAT MAY BE IMPOSED ON ANY TAXPAYER OR (ii) PROMOTING, MARKETING OR RECOMMENDING TO ANOTHER PARTY ANY MATTERS ADDRESSED HEREIN.

You (and your employees, representatives, or agents) may disclose to any and all persons, without limitation, the tax treatment or tax structure, or both, of any transaction described in the associated materials we provide to you, including, but not limited to, any tax opinions, memoranda, or other tax analyses contained in those materials.

The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser.

Tuesday, February 2, 2021

Strafford Webinar

Section 754 Elections on Form 1065:

Making Valid Elections, Seeking Relief

For Missed or Invalid Elections

Mastering the Mechanics of Election Statements,

Schedule K-1, Regulation § 301.9100 Relief,

and More

AGENDA

I. Substantive Overview of the Section 754 Election

A. Section 743(b): Transfer of partnership interests

B. Section 734(b): Distributions of property or cash

C. Section 755: Allocation of the §734(b) and §743(b) basis adjustments

II. IRS Form 1065: Tips regarding the Section 754 Election

III. Missed Section 754 Elections: Relief available under Reg. § 301.9100

A. Automatic extensions of time: Reg. § 301.9100-2

B. Non-automatic, discretionary extensions of time: Reg. § 301.9100-3

C. Establishing “Reasonable Action and Good Faith” in a PLR request: Thepositive & negative benchmarks that should be established and discussed

D. Case Studies

IV. Revoking a Section 754 Election

V. Final Takeaway Tips and Q&A

Part I – Overview

A. Section 754: Elective basis adjustments

B. Section 743(b): Transfer of partnership interests

C. Section 734(b): Distributions of property or cash

D. Section 755: Allocation of §734(b) and §743(b) basis adjustments

Section 754

Overview• Under the aggregate theory, a partner’s basis in the partnership interest

equals its share of the partnership’s basis in its assets.• Basis adjustments covered by Sec 754:

• Sale, exchange, or death of a partner • Liquidating distribution of cash in excess of basis• Distribution of property with different tax basis

• Section 754 allows the partnership to adjust the inside basis of the partnership property under Sections 734 & 743.

• Once the election is made, it applies to all such interest transfers and property distributions in current and subsequent tax years.

Section 754

Benefits of Section 754 Elections:• Potential increase in depreciation/amortization expense.• It may reduce §1231 gains or increase §1231 losses on the sale of

partnership property.• Avoid potential character & timing issues on the liquidation of the

partnership.

Section 743

Overview

• Section 743(b) relates to transfers of partnership interests (i.e. sale, exchange, or death of a partner).

• If a Section 754 election is made, the basis of partnership assets are adjusted to reflect the transferee partner’s outside basis.

• The basis adjustment is for the transferee partner only.

• Mandatory basis adjustment if there is a substantial built-in loss.

• Basis adjustments are allocated in accordance with Section 755.

Section 743(d)

Substantial built-in loss =

• Partnership’s adjusted basis exceeds by more than $250,000 the fair market value of such property, or

• Transferee partner would be allocated a loss of more than $250,000 if the partnership assets were sold for cash equal to their fair market value immediately after such transfer.

Exceptions:

• Securitization Partnerships

• Electing Investment Partnerships

Section 743(b)Example #1: Sale of a Partnership Interest

• Partner A sells PS interest to Partner C for $75M

• Partner A tax capital = $10M

Section 743(b)Example #1: Sale of a Partnership Interest (cont.)

Partner C:

• Inherits Partner A’s $10M capital account (§1.704-1(b)(2)(iv)(l))

• Receives a $65M Sec 743(b) basis adjustment

• New asset(s) of $65M placed in service on the date of purchase*Qualified property may be eligible for bonus depreciation (Section 1.743-1(j)-4(i)(B))

Therefore, Partner C’s basis in the PS interest and PS assets are equal

Section 743(b)Example #1: Sale of a Partnership Interest (cont.)

Section 734

Overview• Section 734(b) relates to distributions to partners• Increase the adjusted basis of partnership assets when:

• Money distributed > partner’s outside basis (Section 731(a)(1))• Basis of property distributed > partner’s outside basis (Section 732(a)(2))

• Decrease the adjusted basis of partnership assets when:• Money distributed < partner’s outside basis (Section 731(a)(2))• Basis of property distributed < partner’s outside basis (Section 732(b))

• Mandatory basis adjustment if there is a substantial basis reduction.• Basis adjustments are allocated in accordance with Section 755.

Section 734(d)

Substantial Basis Reduction =

• If the downward basis adjustments under Section 734(b) exceeds $250,000.

Exception:

• Securitization Partnerships

Section 734(b)Example #2: Liquidating Distribution in Excess of Basis

• Partner A has a basis of $10,000 for his one-third interest in partnership ABC. The partnership has no liabilities and has assets consisting of cash of $11,000 and property with a partnership basis of $19,000 and a value of $22,000.

• A receives $11,000 in cash in liquidation of his entire interest in the partnership. He has a gain of $1,000 under section 731(a)(1).

Section 734(b)Example #2: Liquidating Distribution in Excess of Basis (cont.)

• If the election under section 754 is in effect, the partnership basis for the property becomes $20,000 ($19,000 plus $1,000)

Section 734(b)Example #3: Distribution of Property

• In liquidation of his entire interest in the partnership, D received property X with a partnership basis of $11,000. D’s basis for property X is $10,000 under section 732(b).

Section 734(b)Example #3: Distribution of Property (cont.)

• Where the election under section 754 is in effect, the excess of $1,000 (the partnership basis before distribution less D’s basis for property X after distribution) is added to the basis of partnership property Y. The basis of property Y becomes $16,000 ($15,000 plus $1,000).

Section 755

Overview

• Basis adjustments generally reduce the difference between FMV and adjusted basis of the partnership properties.

• Basis adjustments are allocated to partnership property of a like character

• Basis cannot be reduced below zero. If insufficient basis for such property, such adjustment shall be applied to subsequently acquired property of like character.

Section 755

Section 743(b) Basis Adjustments:• Step 1 – Separate the partnership property into capital/1231 and ordinary classes.

• Step 2 – Calculate the amount of income, gain, loss allocated to Buyer from sale of all partnership’s property for FMV. Treas. Reg. § 1.743-1(d)

• Step 3 – Allocate the basis adjustment first, to the ordinary income class, and the excess to the capital asset classes. Treas. Reg. § 1.755-1(b)(2)

• Step 4 – Allocate the adjustment within the class. Treas. Reg.§ 1.755-1(b)(3)• Allocate basis adjustment between and among classes using a hypothetical sale

approach

Section 755

Section 734(b) Basis Adjustments:

• Basis may be allocated only to property of a character similar to that of the distributed property.

• Use a section 732(c) approach to allocate the adjustment to property within a class in proportion to, and to the extent of unrealized appreciation/depreciation, then in proportion to FMV/ATB.

• Adjustments must be allocated to capital gain classes where the cause is a section 731(a)(1) gain or section 731(a)(2) loss.

Section 754Foreign Partnerships

• Form 1065 filing requirement. Treas. Reg. § 1.6031(a)-1(b)(5) provides the following:

• Certain partnership elections. For a partnership that is not otherwise required to file a partnership return, if an election that can only be made be the partnership under section 703 (affecting the computation of taxable income derived from a partnership) is to be made by or for the partnership, a return on the form prescribed for the partnership return must be filed for the partnership. Unless otherwise provided in the form or the accompanying instructions, a return filed solely to make an election need only contain a written statement citing paragraph (b)(5)(ii) of this section, listing the name and address of the partnership making the election, and clearly identifying the specific election being made.

Section 754Foreign Partnerships

• Treas. Reg. § 1.6031(a)-1(b)(5) continues to provide the following:• A return filed under paragraph (b)(5)(ii) of this section solely to make an

election is not a partnership return. Thus, such a return is not a return filed under section 6031(a) for purposes of sections 6501 (except regarding the specific election issue), 6231(a)(1)(A), and 6233. The return must be signed by— (i) Each partner that is a partner in the partnership at the time the election is made; or (ii) Any partner of the partnership who is authorized (under local law or the partnership’s organizational documents) to make the election and who represents to having such authorization under penalties of perjury.

Part II - IRS Form 1065: Making the Election

A. IRS Form 1065 – Check the Box

B. IRS Form 1065 & Schedule K-1 - Statement Requirements

IRS Form 1065: Making the Election

• Check the box: Form 1065, Page 2, Schedule B, Questions 10a-b

• Check the box: Form 1065, Page 3, Schedule B, Questions 10c

IRS Form 1065: Making the Election

• For a section 754 election to be valid, a written statement must be attached to a timely filed partnership return (including extensions) for the taxable year during which the distribution or transfer occurs .

• See Treas. Reg. §301.9100-2 for 12- month extension of time to file election.

• If a valid election has been made for a preceding taxable year, a new election is not required to be made.

• Reminder: Mandatory adjustments may be required, even without the Section 754 election.

Section 754: Making the Election

• The Section 754 statement shall include:• Name and address of the partnership making the election, and• Contain a declaration that the partnership elects under section 754 to apply the

provisions of section 734(b) and section 743(b).

• The election no longer must be signed by one of the partners (see REG-116256-17).

• Proposed regulations are retroactively effective.

Section 754: Making the Election

Election Sample Statement[Taxpayer Name]

[Taxpayer Address]

[Taxpayer City], [Taxpayer State] [ZIP Code]

Identification Number: [Fed. ID#]

[Taxpayer Name] hereby elects under Code Sec. 754 and Treas. Reg. §1.754-1(b) to apply the provisions of Code Secs. 734(b) and 743(b). The election is effective beginning with the tax year ending [Year End]. A Code Sec. 754 election is not currently in effect.

Section 743(b): Adjustment Statement

Form 1065: Partnership’s Sample Statement[Partnership Name]

[Partnership Address]

[Partnership City], [Partnership State] [ZIP Code]


As required by Treas. Reg. § 1.743-1(k)(1)(i), this statement is submitted by [Partnership Name] as an attachment to its [Year] partnership return.

The name of the transferee is [Transferee Name], TIN [Fed. ID#].

The computation of the basis adjustment is as follows:

[Computation of Basis Adjustment]

The basis adjustment has been allocated to the following partnership properties:

[Partnership Properties]

Section 743(b): Partner Footnote

Schedule K-1: Buying Partner’s Sample Footnote

Section 743(b): Notice to Partnership

Notice to Partnership: Buying Partner’s Notice of Transfer of Units[Transferee Name]

[Transferee Address]

[Transferee City], [Transferee State] [ZIP Code]


Submitted to:

[Partnership Name]

[Partnership Address]

[Partnership City], [Partnership State] [ZIP Code]

As required under Treas. Reg. § 1.743-1(k)(2)(i), [Transferee Name] is notifying you of a sale or exchange of a partnership interest that occurred on [Date].

The transferor's information (if ascertainable) is as follows: [Enter the name, address and taxpayer identification number of the transferor (if ascertainable). If not ascertainable, state that fact. Also, describe the relationship (if any) between the transferee and the transferor.]

Liabilities assumed: [Enter the amount of any liabilities assumed or taken subject to by the transferee. If none, state that fact.]

Payment for the interest: [Enter the amount of any money or the fair market value of any other property delivered or to be delivered for the transferred interest in the partnership. If none, state that fact.]

Additional information: [Provide any other information necessary for the partnership to compute the transferee's basis. If none, state that fact.]

Under penalties of perjury, I declare that I have examined the information contained in this notice, and, to the best of my knowledge and belief, the facts presented in the notice are true, correct and complete.

________________________________________ Date: ____________________[Transferee Name]

Section 734(b): Adjustment Statement

Federal Elections

Description: §734 Adjustment Schedule

Form & Line/Instruction Reference: Schedule B, Line 10B

Regulation Reference: §734(B)

In the year ended 12/31/2020, [Partnership Name] elected under IRC §754 to adjust the basis of partnership property. [Partnership Name] made a distribution to [Partner Name] resulting in an optional basis adjustment to partnership assets under §734. Pursuant to IRC §734 and §755 and the regulations thereunder, the determination and allocation of such adjustments are as follows:

Increase in the basis of partnership property: [Amount]

The basis adjustment was computed as a result of the capital gain recognized by the distributee partner, upon a distribution in excess of basis in the amount of $100,000.

Allocation of basis adjustment:

[Asset Name]: [Amount]

Pamela A. Fuller, Esq. Zahn Law Group Tully Rinckey Counsel (Tax, M&A, International) Tax Counsel

www.zahnlawgroup.com www.tullylegal.com

[email protected] [email protected]

New York, NY New York, NY

Ms. Fuller is a corporate and international tax attorney with over 20

years experience advising a wide variety of clients—including joint

ventures, private equity funds, private and public companies (domestic and

foreign) and their executives, “start-ups,” and government entities--on

transactional, investment, and supply-chain strategies to achieve optimal tax

and business results. She has particular expertise in structuring crossborder

mergers and acquisitions.

Ms. Fuller provides tax planning services across most industry

sectors, including software & emerging digital technologies, investment

management, financial services, real estate development, healthcare,

pharmaceutical, construction & engineering, infrastructure, energy, and

retail. She also has substantial experience resolving U.S. federal, state, and

foreign tax controversies, including transfer pricing issues--skills Ms. Fuller

first acquired when served as Attorney Advisor to the Chief Judge of the

U.S. Tax Court earlier in her career for three consecutive terms.

Ms. Fuller holds an LL.M. in Tax Law from New York University

School of Law, where she served as Graduate Editor of that school’s

international law review and completed post-LL.M. studies in international

business and comparative law; a J.D. from Seattle University; and a B.A.

from the University of Washington. She is admitted to practice law in

several U.S. state jurisdictions and multiple federal courts, including the

U.S. Tax Court.

Ms. Fuller regularly speaks on corporate and

international tax issues at conferences sponsored by

various tax bar associations, and publishes in her field.

She sits on several steering committees, including TaxLaw

360’s international tax advisory board, and the New York

State Bar’s “Global Law Week” steering committee. She

is a founding member of the New York City Bar’s

Taskforce on the Independence of Lawyers and Judges,

and a fellow of both the American College of Tax

Counsel, and the American Bar Foundation.

Prior to becoming an attorney, Ms.

Fuller was a business news reporter and an all- news

radio anchor for a highly regarded NBC News affiliate

in Seattle, Washington, covering regional, national, and

international business, as well as geo-political

developments.

III. Missed Section 754 Elections:

Relief available under Reg. § 301.9100

A. Automatic extensions of time: Reg. § 301.9100-2

B. Non-automatic, discretionary extensions of time: Reg. § 301.9100-3

C. Establishing “Reasonable Action and Good Faith” in a PLR request:The positive & negative benchmarks

D. Case Studies

Section 754 Elections: Making Valid Elections; Relief for Missed Elections -- Pamela A. Fuller, Esq.

Zahn Law; Tully Rinckey PLLC

Missed Elections - Reg. § 301.9100 Relief

• Treasury Regulation. §§ 301.9100-1, 2, and 3 are equitable

provisions that allow taxpayer an extension of time to make an

election (often called “9100 Relief”)

• Reg. § 301.9100-1(c): IRS discretion to grant a reasonable

extension of time for making an election

• Reg. § 301.9100-2: Automatic extensions of time for

regulatory and statutory elections

• Reg. § 301.9100-3: Non-Automatic extensions of time for

regulatory elections that do not meet the requirements of Reg.

§ 301.9100-2



Automatic Relief: Reg. § 301.9100-2

• 9100 Relief is granted automatically if corrective action is

taken within 6 or 12 months of the due date of the return,

including a valid extension, for certain regulatory elections.

– Reg. § 301.9100-2(a)(2)(vi) specifies that Section 754 elections are

eligible for an automatic 12-month extension.

• Taxpayer must file an amended return with a signed partner

consent statement attached to the return.

– The following should be written at the top of the amended return:

“FILED PURSUANT TO Regulation § 301.9100-2”.

• No private IRS letter ruling is required; thus no IRS user fees

apply.



Discretionary Relief: Reg. § 301.9100-3

• Requests for extension of time to elect Section 754 that do not meetthe requirements for “automatic” relief under Reg. § 301.9100-2,MUST be made under Reg. §301.9100-3.

• Private Letter Ruling (PLR) request is required. (Note: AlthoughIRC § 754 requires “the partnership” to file the Section 754 election, it isusually “the taxpayer” (e.g., the surviving or succeeding partner) whosereturn is affected that is filing the PLR (on behalf of the partnership).

• User fee must be paid.

• IRS, in PLRs, rule on points of law—not facts. IRS will not, in aPLR request, make factual inquiries. Thus, it is very important thatthe PLR request submission clearly set forth all relevant facts,substantiated by affidavits and other forms of proof. See Rev. Proc.2020-1 (Appendix C) for check list of all requirements (updatedeach year). See Rev. Proc. 2021-1 (clarified procedures inadditional Appendices).



Two-Part Substantive Test for Non-Automatic,

Discretionary Relief : Reg. § 301.-9100-3

• Reg. § 301.9100-3 sets forth a 2-part test for non-automatic,discretionary relief:

“Requests for relief…will be granted when the taxpayers provides

evidence (including affidavits…) to establish to the satisfaction of the

Commissioner that

1. the taxpayer acted reasonably and in good faith, and

2. the grant of relief will not prejudice the interests of the

Government.”

• Note flush language of Reg. § 301.9100-3(a):

“Requests for relief subject to this section will be granted when the taxpayer

provides the evidence…” (Regulatory language implies that although the

evidence must satisfy the Commissioner, if such evidence is adequate, the IRS

must provide relief.)



Establishing “Reasonable Action and Good Faith” in the PLR Request: The 5 Positive Benchmarks

The Regs at § 301.9100-3(b)(1) set forth 5 situations in which the taxpayer will be “deemed to have acted reasonably and in good faith.”

The positive benchmarks, explicitly listed, include:

1. Taxpayer requests relief before the IRS discovers the failure to make atimely election;

2. Taxpayer failed to make the election because of “intervening eventsbeyond the taxpayer’s control”;

3. Taxpayer failed to make the election because, after exercisingreasonable diligence (taking into account taxpayer’s experience andcomplexity of return or issue), taxpayer was unaware of necessity ofthe election;

4. Taxpayer relied on the written advice of the IRS; or

5. Taxpayer relied on a qualified tax professional, and the taxprofessional both failed to make the election and failed to informtaxpayer of necessity of making the election.



Establishing “Reasonable Action and Good Faith”:

The 3 Negative Benchmarks (really “exceptions”)

Reg. § 301.9100-3(b)(3) sets forth three situations in which Tp will be “deemed to have not acted reasonably and in good faith.” Courts treat these as “exceptions” to relief, where Tp satisfies one or more of the five positive benchmarks. (E.g., Acar v. CIR, 545 F.3 727 (9th Cir. 2008)).

The three listed exceptions are as follows:

1. Taxpayer seeks to alter a return position for which an accuracy-related penalty either has been or could have been imposedunder IRC §6662 at the time taxpayer requests relief, and thenew position requires or permits a regulatory election forwhich relief is requested;

2. Taxpayer was informed in all material respects of the requiredelection and related tax consequences, but chose not to file theelection; or

3. Taxpayer uses hindsight in requesting relief.



The Positive and Negative Criteria

are applied disjunctively

• Both the 5 positive criteria (or “categories”) and the 3 negativecriteria (or “exceptions” to 9100-3 relief) are applied disjunctively;they do not comprise a balancing test.

• Thus, the PLR request should analyze each of the positive criteria,and 3 regulatory exceptions one by one, to show satisfaction of asmany positive criterions as possible, and that none of the negativecriterions (i.e., the 3 exceptions) apply under the facts.

• Also, the PLR request might be made more persuasive if it asserts thatthe 2 underlying policies of discretionary relief mentioned in thePreamble to Reg. § 301.9100-3 will be served if relief is granted.

– Those 2 mentioned policies are: (1) promoting efficient tax administrationwith time limits on elections, and (2) fairness (i.e., collecting fromtaxpayers only the tax they would have paid if they had been well advisedand fully informed).



Strict Application of Disjunctive Criteria in

showing “Reasonable Action and Good Faith”

• In 2006, the U.S. Tax Court held that “[t]he benchmarks forreasonableness and good faith in section 301.9100-3(b)(1)…aredisjunctive; i.e., the taxpayer need satisfy only [one subdivision (i) –(v)] in order to be deemed to have acted reasonably and in goodfaith. L.S. Vines v C.I.R., 126 T.C. 279 (2006).

• But IRS, in its PLRs, applies each regulatory benchmark strictly.

• Example: “Failed to make election due to intervening eventsbeyond taxpayer’s control”: taxpayer needs to supply affidavitsand/or other proof to show that some event (e.g., Hurricane, Act ofGod, or a traumatic death of a partner) not only occurred, but thatsuch event was the “cause” of taxpayer’s failure to timelyelect Section 754.

• Note difficulty of arguing “intervening events caused failure to makethe election” if the relevant tax return, itself, was timely filed.



Taxpayer Requests Relief Before Failure to

Make Election is Discovered by IRS

• The first positive benchmark listed in Reg. § 301.9100-3(b)(1) is whereTp requests relief before the failure to elect is discovered by the IRS.

• Example 1 in Reg. § 301.9100-3(f) shows that taxpayer may be able to availitself of this criterion although years have passed since the failure to makethe election.

– In Example 1, taxpayer’s tax return preparer notices that regulatoryelection was not made 2 years prior. So, taxpayer promptly files forrelief under 9100-3.

– Example 1 concludes that taxpayer is deemed to have acted reasonablyand in good faith because taxpayer requested relief before the failure tomake the regulatory election was discovered by the IRS (and assumingnone of the negative benchmarks are applicable). Note: apparently thepassage of time also does not imply Tp was relying on hindsight—anegative benchmark.



Taxpayer’s Unawareness of Need to

Affirmatively Elect Section 754

• The 3rd positive benchmark in Reg. § 301.9100-3(b)(1) is where factsshow taxpayer was reasonably unaware of opportunity to make theregulatory election.

• Taxpayer must show he/she was unaware of the § 754 election despitereasonable diligence on the taxpayer’s part. (Cannot be willfully blind.)

• In K.Z. Acar v. CIR, where taxpayer attempted to make a late regulatoryelection post-audit (under § 475(f)) and without any claim of interveningevents, US District Court found Acar had submitted no evidence he hadexercised “reasonable diligence” in attempting to learn the tax law, noevidence of relying on a tax professional, and no evidence of relying onIRS.

• Thus, U.S. District Ct. in Acar held: “Ignorance of the tax laws, standingalone, is insufficient to warrant the grant of a retroactive extension oftime” under Reg. § 301.9100-3. Acar v. CIR, LEXIS 60859 (N.D. Cal.2006), aff’d 545 F.3d 727 (9th Cir. 2008).



Reasonable Reliance on Written Advice of IRS

• The 4th positive benchmark listed in Reg. § 301.9100-3(b)(1) is wherefacts show taxpayer “[r]easonably relied on the written advice of the IRS”in its failure to timely make the election.

• Reasonable reliance on written advice of the IRS could possibly occur in acomplex tiered partnership structure where § 754 elections are required tobe made for each partnership in a chain, and the IRS had issued somethingin writing indicating that the election was properly made for eachpartnership—but in fact, one of the § 754 elections with respect to one ormore partnerships was not valid.

• If reliance on the IRS’s written “advice” (that all the elections were properlymade) is reasonable, then such writing should constitute evidence that this4th benchmark is satisfied.

• Other examples of “reasonable reliance on written advice of IRS”??



Reasonable Reliance on Qualified

Tax Professional

• The 5th positive benchmark in Reg. § 301.9100-3(b)(1) is where facts showtaxpayer “[r]easonably relied on a “qualified tax professional” (including oneemployed by the taxpayer), and the tax professional failed both to (1) make the §754 election, and (2) to advise taxpayer of opportunity to make the § 754election.

• Reliance on tax professional, however, is not reasonable if taxpayerknew, or should have known, either that:

- Tax professional was not competent, or

- Tax professional was not aware of all relevant facts. (Reg. §301.9100-3(b)(2); PLR 8817082.

• Example: If partner-spouse dies, triggering a transfer of a partnership interestto a surviving partner, and surviving partner fails to inform CPA of partner-spouse’s death, he/she may not be able to argue “reasonable reliance on taxprofessional” who failed to properly advise. PLR 8817082. (Maybe argue deathwas intervening event causing PTSD of surviving partner, who failed to informCPA.)



1st Exception: Where Tp seeks to alter a tax

return position for which an accuracy related

penalty has been (or could be) imposed

Under the 1st regulatory exception to the general rule, a taxpayer will be deemed NOT to have acted reasonably and in good faith where he is seeking to alter a tax return position for which an accuracy related penalty under § 6662 has been or could be imposed (and that new position, if allowed, triggers the opportunity to make the regulatory election—i.e., here, the § 754 election). Reg. § 301.9100-3(b)(3)(i).

• The accuracy related penalty under § 6662 must be asserted by the IRSat the time 9100-3 relief is sought.

• Example: Assume a partnership failed to take into account a deemeddistribution of property to a partner which, if properly accounted for,would have triggered the opportunity to elect § 754. If the IRS hasalready asserted a penalty under § 6662, then the exception applies, andno discretionary relief will be granted for failure to timely elect § 754.



2nd Exception: Taxpayer was sufficiently

Informed and simply Chose Not To Elect

Under the 2nd regulatory exception, a taxpayer will be deemed NOT to have acted reasonably and in good faith where taxpayer “[w]as informed in all material respects of the required election and related tax consequences, but chose not to file the election[.]” Reg. § 301.9100-3(b)(3)(ii).

• PLR 8817082 (Feb. 3 1988) is instructive: It was issued under former Rev.Proc. 92-85 (predecessor to the § 9100 Regs, upon which the Regs are largelybased), but outcome would be same under Reg. § 301.9100-3.

- Partner in P/S died; no § 754 election was made. Later, application fordiscretionary relief was made, but denied by IRS.

- IRS found P/S’s CPA did not make the § 754 election because he feltnumbers on K-1 “were small” and suggested only a “nominal” interest(apparently because GP failed to inform CPA of sale of P/S property). IRSalso found it took P/S over 3 months to request relief once failure to elect §754 was discovered, suggesting that P/S never intended to make theelection, and that CPA decided it was “not worth pursuing.” Relief denied.



3rd Exception: Taxpayer Uses “Hindsight”

in requesting relief

Under the 3rd regulatory exception, a taxpayer will be deemed NOT to have acted reasonably and in good faith where hindsight is used in requesting the extension of time to make the regulatory election (here a § 754 election).

Par. (b)(3)(iii) of Regulation § 301.9100-3 states that:

“If specific facts have changed since the due date for making the election that make the election advantageous to a taxpayer, the IRS will not ordinarily grant relief. In such a case, the IRS will grant relief only when the taxpayer provides strong proof that the taxpayer’s decision to seek relief did not involve hindsight.”

• Hindsight proscription seems to target situations where Tp is trying to usethe election to hedge his bets or manage exposure to future taxconsequences by deliberately waiting to see if election would be cost-efficient, and worth the effort and hassle (e.g., multi-bases assets).



IRS often denies PLR relief on basis that

“hindsight” was used where P/S assets were sold

• PLR 8817082: IRS denied Tp’s request for a PLR to extend time to make a§ 754 election because, among other things, the P/S’s main asset had beensold prior to seeking 9100 relief.

• PLR 8220115 (Feb. 22, 1982): Partner X died, and X’s estate did not makea § 754 election. Executor of X’s estate later learned about benefit of election,and directed P/S to seek discretionary relief under the predessor to Reg. §301.9100-3. IRS, however, refused to grant an extension of time to elect § 754because the P/S’s main asset had been sold, and the IRS apparently found thismeant that the taxpayer was impermissibly using hindsight in decidingwhether or not to make the election.

• But do the above PLRs make sense given that the § 754 election takes asnapshot of the P/S’s assets’ bases and the value of the P/S interests onthe date of the triggering property distribution or transfer of the P/S interest?

• Does the 754 election really provide an objective opportunity to “hedge” apartner’s exposure to tax—allowing the taxpayer to wait & see?



Seminal U.S. Tax Court case on Hindsight Proscription

in Seeking 9100 Relief: Vines v. CIR (2006)

Issue in Vines: Whether Tp should have been granted an extension of time, under Reg. § 301.9100-3, to make elect § 475(f) (a regulatory election), which was denied by IRS in PLR request.

Facts of Vines: Mr. Vines, an attorney, had realized > $ 35 M in fees in 1999 and 2000 from settling a class action lawsuit. Vines closed his law practice, and started “day trading” securities from his home office. But Vines used margin borrowing as part of his securities trading strategy. In April 2000, Vines realized net trading losses totaling > $25M and his securities accounts were liquidated.

Neither Vines nor his longtime CPA had heard of the § 475(f) election which, if timely filed, allows a taxpayer engaged in the trade/biz of securities trading to elect the mark-to-market method of accounting—treating the securities as sold for FMV on last business day of taxable year.



Vines v. CIR (2006) – Seminal “Hindsight” Case

involved the Mark-to-Market Election of § 475(f)

IRC § 475(f) mark-to-market election has 2 critical features:

• Creates a taxable “income recognition” event (although securities are notsold to anyone), and

• Changes character of realized gains & losses from capital to ordinary. Thus,if trader has losses, electing § 475(f) will turn the year’s trading losses fromrestricted capital losses into “ordinary losses,” which can be deductedagainst ordinary income. But if trader has large gains, it is better not toelect §475(f), so those gains will be taxed at a lower capital gains rate.(Thus, hindsight could be useful.)

• § 475 election must be made on tax return for the year preceding the year inwhich the mark-to-market treatment will apply. (Ex. If securities traderwants to mark-to-market trades for 2017 calendar year, she must elect byApril 15, 2017.) Thus, 3 months of hindsight opportunity are built-into therule.

• § 475(f) election is revocable only with IRS permission.



Hindsight 0pportunity in § 754 Election

analyzed in light of Vines v. CIR (2006)

IRS argued in Vines: Granting Mr. Vines extension of time to elect § 475(f) would give him the impermissible benefit of hindsight so as toturn unrealized capital losses into ordinary ones so as to offset themillions in ordinary income he had earned in 1999.

Tax Court found in Vines: Vines conducted no trading activities between the time his tax return was due (i.e, the date he could have made the § 475(f) election had he known about it), and the date, months later, when he hired a law firm to file for 9100-3 relief through the PLR procedure. So, subjectively, Vines did not benefit from hindsight.

Tax Court stated: “the relevant inquiry is whether allowing a late election gives the taxpayer some advantage that was not available on the due date.”



Hindsight 0pportunity in light of Vines v. CIR (2006) (cont’d)

Tax Court, in Vines, held:

“the only fact that changed after the due date for making the election was the discovery of the availability of the election itself. * * * If a late election is allowed, [Vines] will not be entitled to anything more than that to which he would have been entitled had he timely made the election. The allowance of the election is consistent with the [policy enunciated in] the preamble to the regulations.” [Vines v. CIR, at 293].

Tax Court distinguished prior cases:

Taxpayers in Lehrer v. CIR (TC Memo 2005-167), according to court, were “classic example” taxpayers seeking to use benefit of hindsight by trying to use § 475(f) election as a hedge against volatility of the market--to “retroactivelyconvert their capital losses into ordinary losses several years after the fact, withcontinued trading in the interim…”



Objective opportunity for using Hindsight in

§ 754 Election as compared to the § 475(f) Election

§ 754 election does not create the same objective opportunities for usinghindsight as does the § 475(f) election, for which the proscription againsthindsight may have been tailor made.

• § 754 does not create trigger a conversion of capital losses intoordinary losses,

• § 754 does not create a taxable event

• § 754 takes a “snap shot” of partnership’s capital accounts on the datethat the P/S either distributes property or date that a P/S interest istransferred, and then necessitates a comparison of those assets’ taxbases to the partner’s outside basis in the P/S interest.

• Arguably, the § 754 election cannot be used as a “hedgingtool” because virtually all relevant facts are known on theday of the election…so there’s really no advantage in“waiting to see” what happens.



Is decision to elect § 754 informed by passage of time--such

that IRS could argue impermissible hindsight was used ?

• Electing § 754 creates multiple asset bases, which can be complicated andtime consuming to allocate under § 755.

• There may be some advantage in taking time to weigh whether the time,complexity, and effort of electing § 754 is outweighed by getting a stepped up

(or stepped down) basis in the partnership assets.

• Drawbacks to § 754 election include:• Recordkeeping is a burden• Can cause both a step-up and step-down in asset bases (thus, for e.g., election is

not desirable when discounts on outside P/S interest would reduce decedent’sshare of inside basis of P/S assets to below her share of their cost basis.

• Election affects every partner from that point forward, and applies to distributions.

• But all these factors are capable of being weighed by the general partner, or his taxadvisor on date that right to make the § 754 Election arises—the wisdom of making

the Election is not further informed by the passage of time. Thus, there is notmuch objective opportunity for the use of hindsight!



Proposed Strategy: Argue absence of both the objective opportunity

and Tp’s subjective intent to use hindsight in electing § 754

Given the number of PLRs that have denied Taxpayer’s request to extend the time for electing 754 under Reg. § 301-9100-3 (especially

when P/S assets are sold), it may be wise to argue both that

1. the § 754 election, by its nature, does not present an objective

opportunity to use hindsight in a hedging manner, and

2. taxpayer, subjectively, did not use hindsight in seeking to makeretroactive § 754 election (because, for example, Tp did not know

of election’s availability or significance).



IRS granted PLR Request for more time to elect § 754

(even though TP’s P/S assets had already been sold)

PLR 109101-17: Very terse PLR (perhaps intentionally terse so that it is more difficult to use it as unofficial precedent). (PLR was issued in 2017.)

Background facts: Involved complex tiered P/S structure, and a trust; 3 partners, including H & W; one partner died under particularly sad circumstances; Tp’s tax advisors failed to both make and inform surviving partner of opportunity to elect § 754; however, partner and P/S took a lot of time to seek relief and in meantime all the assets of the 8 partnerships in the structure were sold.

PLR is available at: https://www.irs.gov/pub/irs-wd/201736007.pdf (But many facts, seemingly key, are left out of the PLR. IRS maintains PLRs have no precedential value, although practitioners frequently cite them.)

Involved 8 partnerships in tiered structure: PLR-109101-17, PLR-112201-17, PLR-112202-17, PLR-112203-17, PLR-112204-17, PLR-112205-17, PLR-112206-17, PLR-112207-17, PLR-112208-17



Sept. 2017 PLR: IRS Granted more time to elect § 754

(despite fact P/S assets had been sold) (continued)

In requesting relief in PLR 109101-17 (et seq.) Tp argued:

• 4 of the 5 positive benchmarks listed in Regs for “reasonableness and good faith”were present.

• None of the 3 regulatory exceptions applied.

• Govt’s interests would not be prejudiced (and Tp was willing to waive SOL as toany closed tax years if necessary). Tax policy arguments also were made.

• In particular, PLR request went into great detail as to fact that there was neitherany objective opportunity in a § 754 election to use “hindsight” (distinguishingother mark-to-market/ 475(f) election cases), and regardless, Tp had nosubjective opportunity to use hindsight because he did not know, despite his highlevel of education and evinced business acumen, what a § 754 election was, andhis tax advisors failed both to tell him or make the election.

• Facts surrounding death of partner/spouse (which triggered right to elect §754)were particularly traumatic and sympathetic, so that may have swayed IRS ingranting relief.



Tp must also show that a grant of relief will not

prejudice the Govt’s interests

• To establish Tp acted “reasonably and in good faith,” IRS must alsobe satisfied that a reasonable extension of time to make the § 754election will not whipsaw or “prejudice” the Govt’s interests.

• This is the second part of the 2-part test.

• The Government’s interests are viewed as prejudiced (according tothe Reg.) if “granting relief would result in a taxpayer having a lower tax

liability in the aggregate for all taxable years affected by the election thanthe taxpayer would have had if the election had been timely made (takinginto account the time value of money).” [emphasis added].



Govt’s Interests Cannot be Prejudiced by a

Reasonable Extension of Time (cont’d)

• “Similarly, if the tax consequences of more than one taxpayer areaffected by the election, the Government’s interests are prejudiced ifextending the time for making the election may result in the affectedtaxpayers, in the aggregate, having a lower tax liability than if theelection had been timely made.” Reg. § 301.9100-3(c)(1)(i).

• But note: Inquiry is not whether a partner(s) would save moneyfrom having the § 754 election in effect. Rather, the inquiry iswhether extending the time for making the election wouldnecessarily make the aggregate taxes lower as compared to theresults if the election had been made on time.

• Thus, because a § 754 election takes a snapshot of asset bases andrelevant values (frozen in that time), it is difficult to imagine asituation where the results from making a late election will differfrom results obtained in making a timely election.



Independent Auditor may help prove that Extension of

Time would not be Prejudicial to IRS

• IRS may condition grant of relief on Tp providing IRS with statement fromindependent auditor certifying that Gov’t will not be prejudiced becausegranting relief will not result in taxpayer (or other affected taxpayers) having alower tax liability than if the election had been timely made.

• Policy arguments: not only will the Govt’s interests not be prejudiced, but theunderlying policies of § 743(b), §734(b), and §754 would be well served if extensionis granted.

• In cases where a co-partner dies, and P/S interest passes via his estate to a survivingbeneficiary partner, the tax policy of § 1014(a) (and in community property states, thepolicy of §1014(b)(6), imputing a “transfer” of surviving spouse’s property forpurposes of § 743(b)) would be undermined if §754 election is not allowed.

• The legislative history of the above provisions makes clear that Congress has longbelieved that surviving spouses and surviving business partners should not be taxedon the appreciation in the property they receive by reason of a partner’s (orpartner/beneficiary’s) death.



Is a § 754 Election made in connection with a Disposition of a

Partnership Interest necessarily Prejudicial to the Government?

(Answer: No !!)

• § 754 Election following death of a partner does not affect cost basis ofBuyer of P/S Assets. Reg. §1.743-1(j)(1) provides that the adjustmentunder § 743(b) is personal to the transferee partner, operates outside thepartnership, and has no effect on the computation of the partnership’sincome or loss at the partnership level.

• Thus all buyers of partnership assets following the transfer of a P/Sinterest and a § 754 election take a FMV basis in the assets sold, whichvalue will be the same regardless of whether a § 754 election is timelymade or made retroactively pursuant to 9100 relief.

• The basis adjustments of § 743(b) and/or § 734(b) that are triggeredwhen § 754 is elected do not constitute “changes in accounting methods”or “changes in accounting periods.” Therefore, the special restrictions inReg. §301.9100-3 stating that certain changes in accounting periods &methods cause the Govt’s Interests to be prejudiced do not apply to a requestto extend the time to elect § 754.



If TP’s tax years are at risk of being closed by the § 6501

limitations period—is that risk prejudicial to the Gov’t?

Reg. § 301.9100-3 provides that the interests of the Government are “ordinarily prejudiced” if–

• the taxable year in which the regulatory election should have been madeor any taxable years that would have been affected by the election had itbeen timely made are closed by the periods of limitations on assessmentunder section 6501(a) before the taxpayer’s receipt of a ruling grantingrelief under this section.

• The § 6501(a) limitations period on tax assessments is generally tolled3 years after tax return was actually filed.

• The § 6501(a) limitations period is not suspended by a request for §9100relief.

• Therefore, IRS may condition the 9100 relief on getting thetaxpayer’s consent to extend the limitations period for the taxyear(s) that would have been affected had the § 754 electionbeen timely made. Reg. § 301.9100-3(d)(2).



Procedures for Requesting Relief under

Reg. § 301.9100-3 – i.e., a Private Letter Ruling

• Request for relief under Reg. § 301.9100-3 is a request for a privateletter ruling, and thus must be submitted in accordance withprocedures detailed in Rev. Proc. 2021-1 (a new Rev. Proc. isreleased each year).

• How long and detailed? PLR requests have no page limitation;requests may be as short as 12 pages, but are sometimes muchlonger, depending on circumstances.

• Timing of PLR Request: Request for relief can be submitted evenafter an exam of a return has begun, or when issues are beingconsidered by IRS Administrative Appeals or a federal court. (Butmust disclose this status in the PLR request for relief.)

• Appendix C to the Rev. Proc. 2020-1 has “Checklist for a LetterRuling Request” (The same or similar checklist appears in the2021 Rev. Proc.)



Procedures for Requesting Relief under

Reg. § 301.9100-3 – (cont’d)

• IRS will not engage in factual inquiries in PLRs, so it is veryimportant to set forth all relevant facts, and substantiate them withaffidavits and other documents. (Follow the Rev. Proc.!)

• Rev. Proc. 2020-1 (Appendix C) explicitly requires the following:

• An affidavit of the taxpayer (or taxpayer’s rep) detailing the events thatled to failure to make a valid election, and discovery of the failure.

• The affidavit must describe reliance on any tax professional, includingthe professional’s scope of engagement, competence, and knowledge ofthe facts.

• If Tp is relying on fact that tax professional failed to advise taxpayer ofthe § 754 election, or failed to timely elect § 754, should also include theprofessional’s affidavit admitting his/her or the CPA firm’s failure.(Some taxpayers offer to waive right to sue for malpractice if CPA firm“falls on its sword.”)



Other requirements for Requesting Relief in a

Private Letter Ruling for a missed § 754 Election

Rev. Proc. 2017-1 states that taxpayer’s request for relief must also include:

• Detailed affidavits from other individuals having knowledge of events thatled to the failure to timely elect, and discovery of the failure.

• Other affidavits from relevant persons, including the tax return preparer,and any individual who made a substantial contribution to the preparationof the tax return(s).

• Identification and “discussion” of both “Supporting [legal] Authorities” and“Contrary [legal]Authorities”

• Supporting documents to substantiate all asserted facts. (Remember IRSwill NOT make factual inquiries and will deny 9100/PLR relief if asked tofind facts.)

• Relevant tax returns for all years affected by the § 754 election.

• A statement as to when the relevant tax return (or form) used to make theelection was required to be filed, and the date it was actually filed.



Other PLR requirements, user fees, and

application tips if the partnerships are tiered

In addition, the taxpayer’s request for relief must include:

• Declaration (signed & date) by Taxpayer: “Under penalties ofperjury, I declare that I have examined this request, including allaccompanying documents, and to the best of my knowledge and belief,the request contains all the relevant facts relating to this request, andthat these facts are true, correct, and complete.”

• Submission “user fees” for missed elections, which are (as ofJan. 2017):

Currently, one missed election = $10,000

If multiple requests with identical fact patterns, additional missedelections are $2,700 each.

• Tiered Partnerships: can submit one PLR requesting relief, but must includeeach P/S’s legal name, and EIN. Also, make sure you clearly communicate thepartnerships’ relationship to each other. A diagram can be very helpful,substantiated with any documents.



Judicial Review of IRS’s Denial of Relief

(when the relief was sought under Reg. § 301.9100-3)

• There is no separate, “stand alone” right to judicial review of a denial of non-automatic relief, sought by a taxpayer under Reg. § 301.9100-3.

• However, if IRS asserts a tax deficiency as a result of its denial of the requestto extend the time for electing § 754, taxpayer can challenge that IRS denialin a tax deficiency procedure in court.

• Famous examples: U.S. Tax Court reviewed IRS’s decisions to denytaxpayers’ requests for § 9100-3 relief for missed regulatory elections inVines v. CIR, 126 T.C. 279 (2006), in Mezrah v. CIR, TC Memo 2008-123(did not involve § 754).

• U.S. Tax Court has never announced a rule that taxpayer must seekadministrative relief before seeking § 9100 relief in the Tax Court.

• In the tax refund context, however, the Court of Federal Claims has held thata taxpayer cannot raise § 9100 relief for the first time under the “substantialvariance doctrine,” which requires a taxpayer to first present all argumentsadministratively. E. Marandola, Jr., 76 Fed. Claims Ct. 237 (2007).



IV. Revoking a Section 754

Election

.



Revoking a 754 Election – Reg.§ 1.754-1(c)

• Requests for revocation of a Section 754 election must be approved bythe district director for the Internal Revenue Service District in which thepartnership return is filed.

• Application should meet the following criteria:

1. Request should be made no later than 30 days after the close of thetax year in which the revocation is intended to apply;

2. Signed by any one of the partners with authority;

3. Describing the factual grounds and reason the revocation of the §754election is desired.

• Regulations specifically state that the avoidance of a step down inpartnership assets is not an approved purpose.



V. Final Takeaway Tips and Q&A

,



Some Final Takeaways & Tips• IRS’s granting of an extension of time to make the § 754 election is not a determination that the

partnership was eligible to make the election in the first place (or that it was done correctly).

• A late or invalid § 754 election may be corrected under Reg. § 310.9100-2 if filed within 12 months ofthe due date (or extended due date) of the tax return for the year the election was supposed to have beenmade (even if the underlying tax return was filed late).

• If attempting to take advantage of the 12-month automatic extension, do not forget to write “Filedpursuant to Reg. 301.9100-2” on top of the amended return.

• If attempting to qualify for discretionary relief to correct an invalid or late § 754 election, best practicemay be to argue all 5 positive benchmarks in the PLR request (like a brief), as well as why none of the 3“exceptions” (“negative benchmarks) apply. The IRS will not decide factual questions; all facts averredmust be substantiated with sworn affidavits and other documents.

• Although the taxpayer’s alleged “reliance on hindsight” is a common IRS reason to deny 9100discretionary relief, this “exception” may not make much sense to apply in the context of a § 754election given how the election works (so may be wise to make that argument in any PLR request).

• Although there is no stand-alone judicial review of an IRS denial of 9100 relief, a court (e.g., US TaxCourt) may review the government’s denial under its tax deficiency jurisdiction. (The law is unsettledas to whether TP seek 9100 relief at the IRS administrative level before as court will review the denial.)



Questions ??

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