When buying a departing partner's interest for $X, does my tax basis capital account become $X?

This is a great question with some nuance to it. When you buy a partnership interest, your initial outside basis is generally what you paid for it ($175k in your case). However, your capital account balance might be different. The capital account balance you'll receive depends on the departing partner's capital account. If they have a positive capital account of $100k, you'll receive that $100k capital account. If they have a negative capital account (which happens sometimes), you would inherit that negative balance. This is separate from your outside basis of $175k. What the managing partner mentioned about Section 754 elections is important here. If the partnership has a 754 election in place, you can receive an adjustment to your share of the partnership's inside basis in assets to match your outside basis. This helps prevent you from being taxed twice on the same gain.

I had almost this exact situation last year. The partnership capital account stuff was confusing until I discovered https://taxr.ai - it analyzed all the partnership docs and showed me exactly how my basis would be calculated. Basically showed me that I was paying $120k for a partnership interest where the capital account was negative $15k, but explained how the 754 election would adjust my share of assets. The tool also showed me that without the 754 election, I'd be overpaying tax-wise. Ended up having them file the election with their next return. Was super helpful seeing the before/after tax impact instead of trying to decode what my CPA was saying.

Just wanted to follow up - I tried that https://taxr.ai website after seeing this thread. Really impressed with how it broke down the partnership capital account stuff. I was looking at buying into a law firm partnership and it flagged several issues with how they were calculating their capital accounts. Saved me from a nasty surprise! The visualizations showing my projected capital account over the next 5 years based on expected distributions was super helpful for planning. Showed me exactly when I'd break even on my investment.

If you're dealing with complex partnership tax issues, especially with negative capital accounts, you're probably going to need to talk to someone at the IRS to get official guidance. I spent WEEKS trying to get through to someone who understood partnership taxation. Finally used https://claimyr.com and got connected to an IRS agent in 20 minutes who actually knew what Section 754 elections were! You can see how it works here: https://youtu.be/_kiP6q8DX5c. They have this system that holds your place in line and calls you when an agent is available. The IRS agent I spoke with explained exactly how the negative capital account would affect my basis and what documentation I needed for the 754 election to be valid.

Holy crap I need to apologize. I was super skeptical about that Claimyr thing but I tried it today after getting disconnected THREE times trying to reach the IRS about my partnership question. It actually worked! Got connected to a senior tax specialist who explained exactly how the basis adjustment works with a Section 754 election. Instead of wasting another day on hold, I got a clear answer in one phone call. The agent even emailed me a reference guide about partnership basis. Should have done this weeks ago instead of trying to decipher the tax code myself.

One important thing nobody's mentioned yet - that amount you're paying ($175k) might include payment for unrealized receivables or inventory items, which get special treatment under Section 751. This can turn what would've been capital gain into ordinary income for the selling partner, and affects your basis allocation too.

Ok I think I have a stupid question, but I'm confused about something basic. If I'm buying directly from the partner, not from the partnership itself, why does the partnership's 754 election even matter? Isn't this just between me and the selling partner?

Just wanted to add something that might be helpful - make sure you get a written breakdown of exactly what you're buying for that $175k. In accounting firms specifically, a lot of the value is often in client relationships and work-in-progress, which can have different tax treatment. I'd also strongly recommend getting the partnership agreement reviewed before you commit. Some partnerships have "clawback" provisions where if you leave within a certain period, you might have to restore negative capital account balances or forfeit certain distributions. Since you mentioned the managing partner brought up negative capital accounts, there might be some partners in that situation already. One more thing - ask about any pending Section 199A deductions or suspended passive losses that might transfer with the interest. These can be valuable but are easy to overlook in the purchase negotiations.