The K-1 (Form 1065) mistake that haunts an estate

A partner dies. The estate settles. Life goes on. Then, a year or two later, the successor partner opens a Schedule K-1 (Form 1065), Partner’s Share of Income, Deductions, Credits, etc., that makes no sense. Taxable income shows up even though the inherited partnership interest should have stepped up in value. Depreciation deductions that should exist simply aren't there. Nobody did anything wrong on purpose, but somebody missed a filing deadline that had nothing to do with the estate return and everything to do with the partnership itself.

That's the quiet danger buried inside §§754 and 743, and it's exactly why tax professionals who handle partnerships need to understand it cold.

The basis mismatch nobody warns you about

When someone inherits a partnership interest, that interest generally steps up to fair market value (FMV) as of the date of death under §1014. Sounds simple enough. Here's the catch: the partnership's assets don't get that same step-up automatically. The partnership keeps its old "inside basis" on its books, even though the successor partner is now holding an interest with a brand-new "outside basis." Two different numbers, two different partners, one very confused set of tax returns.

Left uncorrected, that gap can force the successor partner to report gain on appreciation that happened before they ever owned the interest, or lose out on depreciation they're rightfully entitled to claim.

How §754 closes the gap

This is where §754 earns its keep. A valid §754 election allows the partnership to make an optional basis adjustment under §743(b) whenever an interest changes hands, including through death.

Once the election is filed, it applies to every qualifying transfer going forward, not just the one that prompted it. Under §743(b), the successor partner receives either:

• A positive adjustment, if their basis in the interest is higher than their share of the partnership’s inside basis
• A negative adjustment, if it's the other way around

This adjustment belongs to the successor partner alone. It never touches the other partners' capital accounts or tax items, and its effects must be reflected on that partner's Schedule K-1 going forward.

When the adjustment isn’t optional at all

Here's the twist many practitioners miss: sometimes the partnership doesn't get a choice. If the partnership has a "substantial built-in loss" immediately after the transfer, §743 requires the adjustment automatically, election or not.

That threshold is triggered if either the partnership's total adjusted basis exceeds FMV by more than $250,000, or the successor partner would be allocated a loss exceeding $250,000 on a hypothetical sale of everything at FMV. Skip this step, and you've got a compliance problem, not just a missed opportunity.

The paperwork that makes or breaks the deduction

None of this happens automatically. The §754 election requires a written statement filed with the partnership return for the year of the transfer, by the return’s due date, extensions included. If the partnership misses the deadline, it may qualify for an automatic 12-month extension under Reg. §301.9100-2. Otherwise, the partnership generally must request nonautomatic relief from the IRS.

Separately, when a §754 election is in effect for the year of death, the successor partner must notify the partnership in writing within one year of the death. The notice must be signed under penalties of perjury and include the decedent’s and successor’s identifying information, their relationship, the decedent's date of death, the date the successor became the owner, the fair market value on the applicable valuation date, how that value was determined and any applicable carryover basis. If the successor provides the notice late, the partnership follows special reporting rules until it receives notice and then makes the necessary adjustments on an amended return otherwise filed or its next regularly filed annual return.

Don’t let a missed election cost your client

A partner's death should trigger an immediate checklist: partnership agreement, estate valuation, §754 election status, inside and outside basis, and every deadline attached to these items. Get it right, and you've protected real deductions for a grieving family. Get it wrong, and you've handed the IRS an argument nobody wanted to make.

Want to see exactly how these adjustments play out in real partnership scenarios, step by step?

Join our live webinar on Monday, Oct. 26, 2026, at 2 p.m. CT, Sections 754 and 743 Adjustments Upon the Death of a Partner, and learn how to spot, calculate and properly document §754 and §743(b) adjustments before a client's estate pays the price for a missed election.