Section 754 Election

A Section 754 Election is an IRS election made by a partnership (including venture capital fund partnerships) that allows the fund to adjust the tax basis of its assets when a partner's interest is transferred or when the fund makes certain distributions. In the venture context, a 754 election is most relevant in secondary transactions—when an LP sells their fund interest to a buyer, the buyer's tax basis in the underlying fund assets is stepped up to reflect the purchase price paid, rather than inheriting the selling LP's lower historical basis. Without the 754 election, a secondary buyer could be taxed on gains that accrued before they purchased the interest, creating a phantom tax liability. The election applies to all transfers during the fund's life once made and requires additional accounting complexity (maintaining separate basis calculations for each transferee). Most institutional-quality funds make the 754 election as a matter of course because it facilitates secondary market liquidity and is expected by sophisticated LPs.