A founder I talked to last fall was selling sixty percent of his software-services LLC to a growth-equity buyer. The LLC was taxed as a partnership. He had two co-founders, both rolling a slice of their interests into the new entity, both staying on after the close. The buyer’s tax counsel sent over a draft purchase agreement with a clause requiring the company to make a § 754 election effective for the year of the closing. The founder’s own accountant told him to push back. “That election helps the buyer, not you,” the accountant said. “Refuse it, or charge them for it.”
The accountant was half right. The election does help the buyer. The conclusion — refuse it, or charge for it — was the wrong inference from the right premise. In most LLC-target deals I see, the founder is better off agreeing to the § 754 election and negotiating something specific in exchange, rather than resisting the election outright. Whether the right exchange is a price bump, a more favorable rollover structure, or a tax-distribution covenant in the new operating agreement depends on the deal. But the position of “no election” is almost always worse for the founder than the position of “election plus consideration.”
The mechanics are worth walking through carefully, because the conventional wisdom — that the § 754 election is a buy-side ask the seller should resist — gets the economics backwards as often as it gets them right.
What the election actually does
When a buyer acquires an interest in an LLC taxed as a partnership, the buyer pays cash for an outside basis equal to the purchase price. The LLC’s inside basis in its underlying assets — the depreciable equipment, the customer-relationship intangibles, the capitalized software — does not move. The buyer is now sitting on a partnership interest whose outside basis is much higher than its share of the inside basis in the assets the partnership owns. That mismatch produces a deferred tax cost: when the partnership later sells those assets, or claims depreciation against them, the gain or the deduction flows through to all the partners according to inside basis, and the buyer gets a smaller depreciation deduction (or a larger taxable gain) than its outside basis would suggest is fair.
The § 754 election, made by the partnership itself, fixes this. With the election in place, the buyer gets a § 743(b) adjustment that steps the buyer’s share of the inside basis up (or down) to match the outside basis the buyer paid. The effect runs through depreciation, amortization, and gain calculations for years after the closing. For a buyer acquiring a controlling interest in an LLC with substantial intangibles, the present value of the § 743(b) step-up can be material — often five to fifteen percent of the purchase price in the buyer’s after-tax modeling.
The election is partnership-level, not partner-level. Once made, it applies to every distribution and every transfer in subsequent years, not just to the immediate transaction. The administrative cost of maintaining a § 754 election is real — the partnership accountant has to track separate inside-basis schedules for each partner whose interest was transferred, and the bookkeeping compounds over time. The statute itself is short; the regulations and the implementation guidance run for pages.
Why the conventional “resist the election” advice misses the point
The accountant’s instinct — refuse the election, or charge for it — comes from a defensible place. The election helps the buyer. The founder, as a remaining partner with rolled-over equity, gets nothing direct from the election. The administrative cost of maintaining the election falls on the partnership and therefore proportionally on the founder’s remaining stake. Why would the founder agree to do work for the buyer’s benefit without compensation?
There are three reasons that conventional framing leads founders astray.
First, the election is frequently not actually negotiable on the no-election axis. Most well-counseled buyers will not close on a partnership-interest acquisition without the election. The buyer’s tax model assumes the step-up. If the seller refuses, the buyer reprices the deal downward by the present value of the foregone step-up, or restructures the transaction into something that achieves a similar tax outcome by a different path — most commonly by acquiring the assets directly, or by restructuring the LLC into a check-the-box C corporation pre-close so the acquisition can be treated as a stock-purchase-plus-§-338(h)(10)-equivalent. Both of those alternatives are usually worse for the founder than a straight partnership-interest purchase with the election. The founder thinks the leverage is on the election; the leverage is actually on the deal structure, and refusing the election just pushes the deal toward a structure the founder will like less.
Second, the rolled-over founder is not as harmed by the election as the surface analysis suggests. The § 743(b) adjustment is specific to the transferee — meaning the buyer gets the step-up only on the interest the buyer acquired. The founder’s retained interest does not get a corresponding adjustment downward, but it also does not lose any of the depreciation or other tax attributes it already had. The administrative burden is real but modest in absolute dollars (low five figures per year of accountant time for most mid-market LLCs), and the partnership can negotiate the burden onto the buyer through an operating-agreement provision requiring the new majority partner to bear the cost of maintaining the basis-tracking schedules.
Third, and most importantly, the election creates an opening to negotiate something the founder actually wants. The buyer values the step-up at a calculable present-value number. The founder can attach that value to a specific ask: a higher purchase price on the cash portion, a more favorable conversion ratio on the rolled equity, an improved tax-distribution covenant in the post-close operating agreement, or a clarified treatment of future § 704(c) allocations on the founder’s retained capital. The “election in exchange for nothing” trade is bad; the “election in exchange for [specific concession]” trade is frequently good.
The specific concessions that are worth asking for
The first ask, and the most direct, is a price adjustment. The buyer’s tax counsel can model the present value of the § 743(b) step-up at the buyer’s expected discount rate and depreciation profile. That number — typically five to ten percent of purchase price in a deal with substantial intangibles, somewhat lower in a deal with mostly hard assets — is the buyer’s marginal willingness to pay for the election. A founder who walks into the negotiation with the election as a price input rather than a procedural matter can capture some portion of that value as additional consideration. The buyer will not pay the full present value, because the buyer also faces administrative burden and timing risk on the step-up, but capturing twenty-five to fifty percent of the modeled benefit is a reasonable target.
The second ask is a tax-distribution covenant in the new operating agreement. The rolled founder’s retained interest in the post-close LLC is a flow-through, and the founder will owe income tax on allocated income whether or not the LLC distributes cash to cover it. A standard tax-distribution covenant requires the LLC to distribute cash to all members in proportion to their share of taxable income at an assumed highest marginal rate. The buyer, as the new majority, will sometimes resist this — it constrains the post-close cash strategy of the new entity, and the buyer may prefer to reinvest. The § 754 election conversation is a natural opening to ask for the covenant: “I will agree to the election that creates your step-up; you agree to the tax-distribution covenant that ensures I am not paying tax on phantom income without cash to cover it.” The two issues sit on the same side of the partnership-taxation ledger, and the trade is intuitive enough that it usually closes.
The third ask, more technical, is on § 704(c) treatment. When the founder’s pre-close interest had built-in gain — which it usually does, on appreciated software, customer relationships, or capitalized goodwill — § 704(c) requires the partnership to allocate that built-in gain to the founder when it is later recognized, even though the partnership’s overall economics have changed. The election does not directly affect § 704(c), but the operating-agreement drafting around § 704(c) (traditional method, curative method, or remedial method) does. The choice of method has real present-value consequences for the founder over the holding period of the rolled interest, and the buyer’s counsel will frequently default to the remedial method (which is buyer-friendly on the depreciation side) without negotiating. The founder can use the election conversation to put the § 704(c) method on the table and push for the traditional method or a negotiated curative-method allocation that preserves more of the founder’s economic position.
The fourth ask, simpler, is administrative cost. The partnership’s basis-tracking schedules will get more complicated after the election. The post-close operating agreement should specify who pays for that — the partnership, with the cost flowing pro rata to all members, or the new majority partner directly. A founder who is taking on a meaningfully smaller share of the post-close LLC has a fair argument that the administrative burden created by the buyer’s election should sit on the buyer’s books. This is a small-dollar fight but the principle matters: the founder is not subsidizing the buyer’s tax planning.
The structural alternative the founder should be ready for
If the buyer insists on the election and the founder cannot extract compensation for it, the founder should at least have a clear-eyed view of what the alternative deal looks like. The two main alternatives are an asset purchase (where the buyer gets a direct step-up by buying the assets at fair value, and the seller’s gain runs through the LLC to the partners) and a pre-close conversion of the LLC to a C corporation followed by a stock purchase with a § 338(h)(10) or § 336(e) election.
Both alternatives have downsides for the founder. The asset purchase strips away the founder’s ability to do a tax-deferred rollover under § 721 — the rollover is now a taxable event, structured as a partial reinvestment of after-tax proceeds. The pre-close conversion creates its own tax friction, depending on the LLC’s balance sheet and built-in gain, and the resulting C-corp structure changes the founder’s post-close tax profile in ways that may be unfavorable for an operator who plans to hold the rolled interest for several years. The asymmetry around tax treatment in PE-style rollover deals is real, and the § 754 election, properly understood, is one of the few buyer-friendly elections that does not actually hurt the seller as much as the surface analysis suggests.
The founder I started this post with renegotiated his deal. He agreed to the election. He got a one percent price bump (the buyer’s counsel had modeled the step-up at four percent of purchase price, so he captured a quarter of the value), a tighter tax-distribution covenant in the post-close operating agreement, and a curative-method § 704(c) allocation. None of that would have been on the table if he had refused the election. The closing happened on schedule. His co-founders, who had read the same accountant memo, were pleased he had asked. LLC-target M&A work rewards the founder who understands the tax architecture of the deal well enough to trade in it, and § 754 is one of the cleanest trades on the board.
If you are selling a partial interest in an LLC taxed as a partnership and the buyer has asked for a § 754 election, feel free to reach out to my firm manager, Magda, at Magda@montague.law, or fill out our contact form. Mention you read this post.
— John
