Are you thinking about purchasing interest in real estate? Since real estate is often owned within partnerships, one way to invest in real estate is to purchase an interest in a real estate holding partnership from a previous member, or if you are currently invested in real estate through a partnership you can increase your ownership by buying out another partner.
In these situations you may be entitled to a “step up in basis” (remember that basis is normally just the original purchase price) for the purchased property, even though you are buying a partnership interest. Partnership interests are often purchased for an amount greater than the tax basis of the interest that is purchased.
Two reasons for a change in basis in real estate partnerships:
Property is likely to have appreciated in value since the time it was originally placed in service by the partnership
Significant depreciation may have been taken on the property.
The difference between what you pay for the interest in the partnership and the pre-existing tax basis in the interest is what is termed the “step up” in the property’s basis. You are entitled to basis in the property in the amount of what you paid for the interest, just as you would have if you purchased the property directly.
Benefits of step up basis
The benefits of the step up in basis are straightforward. An increase in your tax basis will increase your share of the annual depreciation deductions, reducing your tax burden each year going forward. However, if certain IRS mechanics, rules and procedures are not followed, you could be stuck with the pre-existing tax basis instead. This can easily cost you thousands or tens of thousands of dollars in future tax bills. Unfortunately, this is not an automatic process. You’ll need to consult your CPA.
How to report and claim
The most important part of this post is to understand that in order to claim the step up in basis, the partnership must make a 754 election on their timely filed return. Further, the amount of the step up in basis must be calculated and reported, and allocated between the assets purchased. It is important to have a qualified professional who understands the mechanics and procedures for calculating and reporting the step up in basis so that you don’t miss out on these additional deductions.
By David Olson, CPA
Manager at WHH