Transfer of negative capital account balances from selling partner to new partner

[dfrycpa73]

I have a client with 3 partners (individuals).  In 2019, 2 partners sold their individual interests to 1 individual.  The purchase happened outside the Partnership (i.e. monies were exchanged between individuals).  Both selling partners had negative ending balances in their capital accounts (K-1), so in order to zero out their ending capital accounts for final K-1 purposes, I did an "Other increase" and an "Other decrease" in M-2 for the total negative capital balances, then allocated in Special Allocations appropriately from the old partners to the new partner (thus the new partner is starting with a negative tax basis capital account).  I would like to see if someone has come across a similar situation before to provide feedback on if the above treatment is correct or needs modified.  Also, I presume what the new partner paid would somehow be their beginning basis... but it's confusing since it was paid to the selling partners and not as a contribution to the Partnership.  Any advise would be greatly appreciated... Thanks.

[PhoebeRoberts]

Yes, I believe that transferring the deficit capital account balances to the incoming partner is the appropriate treatment.

Yes, the incoming partner's outside tax basis is determined by what they paid to the outgoing partners. Their capital account will not reflect their outside basis, even if "tax basis" is the capital account method - capital account reflects inside basis.

If your partnership allows or requires a 754 election, that would increase inside basis to match outside basis, with the increase allocated to the incoming partner under Sec 743. Depending on the dollar amounts involved, the accounting fees associated with a 754 election (which will continue forever, bwahahaha) might not be worth getting the additional inside basis.