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Pass-Through Liabilities and Federal
Tax Treatment: Resolving Complex Issues Reporting Liabilities for General or Limited Partnerships and LLCs Given Tax Code Inconsistencies
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Carolyn Turnbull, CPA, MST, Consultant, Orlando, Fla.
Belan Wagner, Managing Partner, Wagner Kirkman Blaine Klomparens & Youmans, Mather, Calif.
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Pass-Through Liabilities and Federal Tax Treatment: Resolving Complex Issues Seminar
Carolyn Turnbull, CPA, MST, CGMA
Independent Tax Consultant
Aug. 28, 2013
Belan Wagner, Wagner Kirkman Blaine
Komparens & Youmans
Today’s Program
Liability Characterization Under IRC Sect. 1001
[Belan Wagner]
Treatment Of Partnership Liabilities Under IRC Sect. 752
[Carolyn Turnbull, Belan Wagner]
Examples Of Taxpayer Situations
[Belan Wagner, Carolyn Turnbull]
At-Risk Rules Under IRC Sect. 465
[Carolyn Turnbull]
Concluding Remarks
[Carolyn Turnbull, Belan Wagner]
Slide 8 – Slide 10
Slide 11 – Slide 32
Slide 33 – Slide 70
Slide 71 – Slide 79
Slide 80
Notice
ANY TAX ADVICE IN THIS COMMUNICATION IS NOT INTENDED OR WRITTEN BY
THE SPEAKERS’ FIRMS TO BE USED, AND CANNOT BE USED, BY A CLIENT OR ANY
OTHER PERSON OR ENTITY FOR THE PURPOSE OF (i) AVOIDING PENALTIES THAT
MAY BE IMPOSED ON ANY TAXPAYER OR (ii) PROMOTING, MARKETING OR
RECOMMENDING TO ANOTHER PARTY ANY MATTERS ADDRESSED HEREIN.
You (and your employees, representatives, or agents) may disclose to any and all persons,
without limitation, the tax treatment or tax structure, or both, of any transaction
described in the associated materials we provide to you, including, but not limited to,
any tax opinions, memoranda, or other tax analyses contained in those materials.
The information contained herein is of a general nature and based on authorities that are
subject to change. Applicability of the information to specific situations should be
determined through consultation with your tax adviser.
LIABILITY CHARACTERIZATION UNDER IRC SECT. 1001
Belan Wagner, Wagner Kirkman Blaine Komparens & Youmans
9
Liability Characterization Under IRC §1001
I. Background
A. Determination of whether a liability is recourse or nonrecourse is
generally made according to state law.
B. Characterization of partnership liability is made at the partnership
level (e.g., see Gershkowitz , TC, 1987)
II. Nonrecourse liability
A. Defined in Black’s Law Dictionary as a “secured loan that allows the
lender to attach only the collateral, not the borrower’s personal
assets, if the loan is not repaid.”
B. A transfer of property that secures a nonrecourse loan to the
creditor in satisfaction of the loan results in gain or loss from a sale
or exchange to the debtor under
1001, equal to the difference
between the debtor’s adjusted basis in the property and the
adjusted issue price of the debt.
10
Liability Characterization Under IRC §1001 (Cont.)
I. Recourse liability
A. Defined in Black’s Law Dictionary as a “loan that allows the lender,
if the borrower defaults, not only to attach the collateral but also
to seek judgment against the borrower’s (or guarantor’s) personal
assets.”
B. A transfer of property to the creditor in satisfaction of a recourse
loan is bifurcated into:
1. Sale or exchange income from the property under
1001, to the
extent of the difference between the property’s FMV and the
taxpayer’s adjusted basis in the property at the time of the
transfer; and
2. COD income, to the extent the adjusted issue price of the debt
exceeds the FMV of the property.
TREATMENT OF PARTNERSHIP LIABILITIES UNDER IRC SECT. 752
Carolyn Turnbull, CPA, MST, CGMA, Independent Tax Consultant
Belan Wagner, Wagner Kirkman Blaine Komparens & Youmans
12
Background
I. A partner’s basis in a partnership interest includes the partner’s
share of the partnership liabilities.
II.
752(a) – Assumption by the partner of partnership debt, or
increase in partner’s share of partnership debt treated as
contribution of money to partnership
III.
752(b) – Assumption by the partnership of partner debt, or
decrease in partner’s share of partnership debt treated as
distribution of money by partnership to partner
13
Background (Cont.)
I.
752(c) – A liability to which property is subject is, to the extent
of the FMV of the property, considered a liability of the owner of
the property
II.
752(d) – In the case of a sale or exchange of a partnership
interest, liabilities are treated in the same manner as liabilities
in connection with the sale or exchange of property not
associated with partnerships.
14
Allocation Of Partnership Liabilities Under §752
• Understand how liabilities affect the calculation of a
partner/member’s basis and at-risk amount in her partnership
interest
• Determine the effect of liabilities on the basis in the investor’s
hands of property received as a distribution from a partnership
• Distinguish between recourse and nonrecourse liabilities of a
partnership
• Measure a partner’s or member’s share of recourse liabilities of a
partnership
15
Allocation Of Partnership Liabilities Under §752 (Cont.)
• Measure a partner’s share of nonrecourse liabilities of a
partnership
• Analyze the impact of a partner guarantee of a recourse or non-
recourse liability of the entity
• Understand the provisions governing allocation of nonrecourse
deductions of a partnership
16
Contribution Of Encumbered Property
I. Net relief of liabilities treated as a distribution of cash
II. Will result in gain to contributing partner at partnership
formation, if net relief of liabilities is greater than basis of
property contributed
17
Distribution Of Encumbered Property
I. Net assumption of debt is treated as a contribution of cash to
partnership.
II. Net relief of debt is treated as a distribution of cash.
18
Allocation Of Partnership Liabilities Under §752
I. Recourse liabilities allocated as if partnership lost everything and
then liquidated (i.e., partnership constructively liquidated) –
what partners would have to repay creditors or other partners
II. Same rules do not apply to nonrecourse liabilities, because no
one would have to repay those liabilities.
20
Recourse Liabilities
I. If any partner or related person bears risk of loss for debt, it is a
recourse debt.
A. Determined without regard for how the liability is
characterized under state law
II. Partner’s share of partnership recourse debt equals the amount for
which the partner or related person bears the economic risk of
loss.
III. Nonrecourse loans recharacterized if:
A. Loan or interest thereon is guaranteed by one or more
partners
B. Collateralized by property owned by a partner
C. Loan obtained from a partner
21
Constructive Liquidation
I. Constructive liquidation – all of the following events are deemed to occur
simultaneously:
A. All of the partnership liabilities become payable in full.
B. With the exception of property contributed to secure a partnership
liability, all of the partnership’s assets, including cash, have a value
of zero.
C. Partnership disposes of all of its property in a fully taxable
transaction for no consideration (except relief from liabilities for
which the creditor’s right to repayment is limited solely to one or
more assets of the partnership).
D. All items of income, gain, loss and deduction are allocated among
the partners.
E. The partnership liquidates.
22
Constructive Liquidation (Cont.)
I. Partners who have deficit restoration provisions are presumed to
contribute any deficit balance in their capital account to the
partnership.
II. Debt allocations based on book capital accounts (and deficits
therein)
III. If the partnership agreement provides for any special allocations,
liability allocations will change every year.
23
Effect Of Partner Guarantees
I. Guarantee of nonrecourse loan makes that loan recourse for
purposes of
752.
II. Loan guarantee is ignored, however, for purposes of allocating
guaranteed debt, unless the guarantor has no further recourse
against remaining partners.
24
Nonrecourse Liabilities
I. Allocated among all partners, limited and general
II. Allocations are generally based on profit-sharing ratios, because
debts will be repaid, if at all, by reduced profit distributions.
25
Nonrecourse Liabilities (Cont.)
I. Partners’ interests in profits considered in following order:
A. Share of partnership book minimum gain
B. Sect. 704(c) minimum gain
C. Other partnership profits
D. Partnerships may choose to allocate “excess” nonrecourse
debt to contributing partner, to the extent of built-in gain
allocable to such partner under
704(c).
26
Minimum Gain
I. Minimum gain is equal to the excess of principal balance of non-
recourse debt over the
704(b) book value of property
encumbered by nonrecourse debt,
II. If book value exceeds tax basis, there will also be tax minimum
gain.
A. If
704(c) applies to this portion of minimum gain, allocation
of underlying nonrecourse debt may be affected.
27
Example
I. Partnership AB has property encumbered by nonrecourse debt that was previously
contributed by Partner B.
A. Book value of property is $250,000, tax basis is $200,000, and principal balance
of nonrecourse mortgage is $315,000.
B. Book minimum gain is $65,000.
C.
704(c) minimum gain is $50,000.
D. Total minimum gain is $115,000
II. Allocation of the $315,000 nonrecourse liability between partner A and B’s bases is
determined by taking the sum of each partner’s interests in:
A. Tier 1: The partner’s share of partnership book minimum gain ($65,000);
B. Tier 2: The partner’s allocation of tax minimum gain under
704(c) ($50,000); and
C. Tier 3: The partner’s share based on ownership interests ($200,000).
28
Allocation Of Nonrecourse Deductions
I. What constitutes a “nonrecourse deduction”?
A. A nonrecourse deduction is defined as one that reduces
the entity’s net assets (on the
704(b) balance sheet) to a
level below the outstanding principal of its nonrecourse
liabilities
B. To have nonrecourse deductions, there must be no
remaining partner or member capital, or recourse debt, to
absorb the partnership loss.
29
Nonrecourse Deductions
I. Allocations will be recognized if:
A. Partnership agreement calls for proper maintenance of capital
accounts.
B. Liquidation proceeds must be distributed based on capital balances.
C. Partnership agreement requires either deficit restoration or
minimum gain chargeback.
D. Allocation must be reasonably consistent with allocations of some
other significant partnership item(s) attributable to the
encumbered property.
E. All other material entity allocations and capital account
adjustments must be recognized under the regulations.
30
Minimum Gain Chargeback
I. “Minimum gain” is equal to the excess of nonrecourse debt over
property basis.
II. Each partner’s share is the sum of the partner’s previous non-
recourse deductions.
III. This gain must first be allocated to partners with deficit capital
balances, to the extent of such deficits.
32
Partner Nonrecourse Debt
I. Partner nonrecourse debt is:
A. Partnership nonrecourse debt for purposes of Reg.
1.1001-2,
and,
B. A partner or related person bears the economic risk of loss
(e.g., because the partner or related person is the creditor
or guarantor).
II. Partner nonrecourse deductions and partner minimum gain are
generally allocated to the partner who bears the economic risk
of loss (or for which a related party bears the risk of loss) for the
partner nonrecourse debt.
A. Partner minimum gain chargeback is allocated to the partner
who received the allocation of nonrecourse deductions.
EXAMPLES OF TAXPAYER SITUATIONS
Belan Wagner, Wagner Kirkman Blaine Komparens & Youmans
Carolyn Turnbull, CPA, MST, CGMA, Independent Tax Consultant
34
Examples based on article from Blake
Rubin, Andrea Macintosh Whiteway,
and Jon G. Finkelstein, “Treatment of
Liabilities as Recourse or Nonrecourse
in a Complex Financial World”,
Journal of Passthrough Entities
(July-August 2010)
35
Example 1: General Partnership With State Law Recourse Liability
AB General
Partnership
A B
Y Third-
Party
Lender
$500,000
recourse loan to
AB Partnership
• How is the recourse loan from Y
allocated to A and B?
• What are the tax implications if AB
Partnership transfers a building
and land with a FMV of $400,000
and a tax basis of $200,000 to Y in
satisfaction of the $500,000 loan? 50% 50%
36
Example 1: ANSWER
I. How is the recourse loan from Y allocated to A and B?
A. Because AB is a general partnership, both A and B will be allocated
$250,000 in debt basis as general partners with respect to the loan
because each bears a 50% economic risk of loss with respect to their
ownership interests in the general partnership.
II. What are the tax implications if AB Partnership transfers a building and land
with a FMV of $400,000 and a tax basis of $200,000 to Y in satisfaction of the
$500,000 loan?
A. $200,000 gain from sale or exchange – this is the difference between AB
Partnership’s tax basis and the FMV of the building and land at the time
of the transfer. (Section 1001)
B. $100,000 CODI – this is the difference between the amount of the
forgiven debt less the FMV of the building and land.
37
Example 2: General Partnership With State Law Nonrecourse Liability
AB General
Partnership
A B
Y Third-
Party
Lender
$500,000 nonrecourse
loan to AB Partnership,
secured only by AB’s
office building
• How is the nonrecourse loan from
Y allocated to A and B?
• How is depreciation from the office
building allocated to A and B?
• What are the tax implications if AB
Partnership transfers the office to
Y in satisfaction of the $500,000
loan? Assume the building has a
FMV of $400,000 and a tax basis
of $200,000 at the time of the
transfer.
50% 50%
38
Example 2: ANSWER
I. How is the nonrecourse loan from Y allocated to A and B?
A. It is allocated between A and B (i.e., 50:50 based upon their share of
partnership profits).
II. How is depreciation from the office building allocated to A and B?
A. Subject to the safe harbor requirements pursuant to Reg. Sec. 1.704-2(b),
nonrecourse deductions, including depreciation, are allocated in proportion
to the partners’ interests (i.e., 50% to A, and 50% to B) in the partnership.
III. What are the tax implications if AB Partnership transfers the office to Y in
satisfaction of the $500,000 loan? Assume the building has a FMV of $400,000
and a tax basis of $200,000 at the time of the transfer.
A. $300,000 gain recognized from sale or exchange of the building – A transfer
of property that secures a nonrecourse loan to the creditor in satisfaction
of the loan results in a sale or exchange to the debtor under Sec. 1001,
equal to the difference between the debtor’s adjusted basis in the property
and the adjusted issue price of the debt.
39
Example 3: General Partnership With State Law “Exculpatory” Liability
AB General
Partnership
A B
Y Third-
Party
Lender`
$500,000 recourse loan
to AB Partnership, but
exculpatory to A and B
• Is the loan treated as a recourse or
nonrecourse loan under §1001?
How about §752?
• How is the loan from Y allocated to
A and B?
• How is depreciation from the office
building allocated to A and B?
• What are the tax implications if AB
Partnership transfers the office to Y
in satisfaction of the $500,000
loan? Assume the building has a
FMV of $400,000 and a tax basis
of $200,000 at the time of the
transfer.
50% 50%
40
Example 3: ANSWER
I. Is the loan treated as a recourse or nonrecourse loan under
1001? How about 752?
A. Under
1001, the loan is recourse to the partnership.
B. Under
752, the loan is nonrecourse to the partners because it is
“exculpatory” to A and B. Under an economic risk of loss analysis, the
partners would not be liable under this loan.
II. How is the loan from Y allocated to A and B?
A. It will be allocated based upon their profits interests.
III. How is depreciation from the office building allocated to A and B?
A. Subject to the safe harbor requirements pursuant to Reg. Sec. 1.704-2(b),
nonrecourse deductions, including depreciation, are allocated in
proportion to the partners’ interests in the partnership.
41
Example 3: ANSWER (Continued)
IV. What are the tax implications if AB Partnership transfers the office to Y in
satisfaction of the $500,000 loan? Assume the building has a FMV of $400,000
and a tax basis of $200,000 at the time of the transfer.
A. $200,000 gain recognized from sale or exchange of the building – this is
the difference between AB Partnership’s tax basis and the FMV of the
building and land at the time of the transfer. (
1001)
1. The gain from the sale or exchange will be allocated to A and B pursuant to
the partners’ interests in the partnership, unless otherwise provided.
B. $100,000 CODI – this is the difference between the amount of the
forgiven debt and the FMV of the building and land.
1. The income from the sale or exchange will be allocated to A and B pursuant to
the partners’ interests in the partnership, unless otherwise provided.
42
Example 4: Limited Partnership With State Law Recourse Liability
AB Limited
Partnership
A B
Y Third-
Party
Lender
$500,000 recourse loan
to AB Partnership. A, as
the general partner, is
fully liable for repayment
of the loan.
• Is the loan treated as a recourse or
nonrecourse loan under §1001?
How about §752?
• How is the loan from Y allocated to
A and B?
• Assume that the loan proceeds
from Y are used to purchase an
office building, which is AB’s only
asset. How is depreciation from the
office building allocated to A and B?
• What are the tax implications if AB
Partnership transfers the office to Y
in satisfaction of the $500,000
loan? Assume the building has a
FMV of $400,000 and a tax basis
of $200,000 at the time of the
transfer.
10% general
partner 90% limited
partner
43
I. Is the loan treated as a recourse or nonrecourse loan under
1001? How about 752?
A. Under
1001, this is a recourse loan to the partnership.
B. Under
752, this is a recourse loan to Partner A because A bears economic
risk of loss.
II. How is the loan from Y allocated to A and B?
A. It is allocated 100% to Partner A because A bears economic risk of loss.
B. None of the loan is allocated to Partner B.
Example 4: ANSWER
44
Example 4: ANSWER (Continued)
III. Assume that the loan proceeds from Y are used to purchase an office building, which is
AB’s only asset. How is depreciation from the office building allocated to A and B?
A. Depreciation is allocated to A and B in accordance with the partnership
agreement provided the allocation has substantial economic effect under Reg. 1.704-1.
B. Based on the facts in this example, an allocation of 10% of the depreciation to
A and 90% of the depreciation to B will likely not have substantial effect if the
allocation would create a deficit balance in B’s capital account.
1. A qualified income offset provision in the partnership agreement will not cause
the allocation to have substantial economic effect because the allocation of
depreciation to B would not unexpectedly cause B’s capital account to go
negative.
2. Neither a partnership minimum gain chargeback nor partner minimum gain
chargeback provision in the partnership agreement would apply because the
debt is neither partnership nonrecourse debt nor partner nonrecourse debt.
45
Example 4: ANSWER (Continued)
IV. What are the tax implications if AB Partnership transfers the office to Y in
satisfaction of the $500,000 loan? Assume the building has a FMV of $400,000
and a tax basis of $200,000 at the time of the transfer.
A. $200,000 gain from sale or exchange of the office – this is the difference
between AB Partnership’s tax basis and the FMV of the building and land
at the time of the transfer. (
1001)
1. The gain from the sale or exchange of the office will be allocated in
accordance with the partnership agreement provided the allocation has
substantial economic effect.
B. $100,000 CODI – this is the difference between the amount of the
forgiven debt and the FMV of the building and land.
1. The CODI is allocated in accordance with the partnership agreement provided
the allocation has substantial economic effect.
47
Example 5: Limited Partnership With State Law Nonrecourse Liability Guaranteed By Partner
AB Limited
Partnership
A B
Y Third-
Party
Lender
$500,000 nonrecourse loan
to AB Partnership, secured
solely by AB’s office
building. A guarantees the
full amount of the debt.
• Is the loan treated as a recourse or
nonrecourse loan under §1001?
How about §752?
• How is the loan from Y allocated to
A and B?
• Assume that the loan proceeds
from Y are used to purchase an
office building, which is AB’s only
asset. How is depreciation from the
office building allocated to A and B?
• What are the tax implications if AB
Partnership transfers the office to Y
in satisfaction of the $500,000
loan? Assume the building has a
FMV of $400,000 and a tax basis
of $200,000 at the time of the
transfer.
10% general
partner 90% limited
partner
48
Example 5: ANSWER
I. Is the loan treated as a recourse or nonrecourse loan under
1001? How
about
752?
A. Under
1001, this is a partnership nonrecourse debt.
B. This debt is a recourse liability under
752. The debt is recharacterized
as a “partner nonrecourse loan” to A, however, because the loan is
nonrecourse to the partnership and A bears economic risk of loss based
upon A’s guaranty of the loan.
II. How is the loan from Y allocated to A and B?
A. The loan is allocated 100% to A. A guaranteed the loan and therefore
bears the economic risk of loss for the debt.
49
Example 5: ANSWER (Continued)
III. Assume that the loan proceeds from Y are used to purchase an office building,
which is AB’s only asset. How is depreciation from the office building
allocated to A and B?
A. If a partner bears the economic risk of loss of a partnership nonrecourse
debt, it is recharacterized as a “partner nonrecourse debt” and any
nonrecourse deductions attributable to that debt must be allocated to
the partner who bears its economic risk of loss, or among all partners
who bear economic risk of loss according to the ratio in which they bear
that risk of loss. (Reg.
1.704-2(b)(4); Reg.
1.704-2(i).) Partner A
guaranteed the debt that is nonrecourse to the partnership and
therefore bears the economic risk of loss even though the debt was
originally a nonrecourse debt. Thus, Partner A will be allocated any
nonrecourse deductions attributable to that debt.
50
Example 5: ANSWER (Continued)
IV. However, assume that Partner A did not guaranty the loan and the loan proceeds
from Y are used to purchase an office building, which is AB’s only asset. How is
depreciation from the office building allocated to A and B?
A. Depreciation from the partnership nonrecourse debt will be allocated in
accordance with the partners’ interests in the partnership. These allocations
will be made in accordance with a partners’ interests in the partnership if the
following rules are followed:
1. Capital accounts are properly maintained.
2. Allocations of deductions attributable to nonrecourse debt throughout the term
of the partnership are reasonably consistent with some other significant
partnership item attributable to the property creating the nonrecourse debt.
3. Either the partner has an obligation to eliminate the deficit balance of his
capital account on liquidation of the partnership or of his interest or the
partnership agreement contains a “minimum gain chargeback.”
4. All other material allocations made by the partnership are in accordance with
the regulations under Section 704(b).
51
Example 5: ANSWER (Continued)
V. What are the tax implications if AB Partnership transfers the office to Y in
satisfaction of the $500,000 loan? Assume the building has a FMV of $400,000
and a tax basis of $200,000 at the time of the transfer.
A. $300,000 gain from sale or exchange of the office – A transfer of property
that secures a nonrecourse loan to the creditor in satisfaction of the
loan results in a sale or exchange to the debtor under
1001, equal to
the difference between the debtor’s adjusted basis in the property and
the adjusted issue price of the debt.
B. This gain is subject to the partner minimum gain chargeback provisions
and would be allocated 100% to A.
52
Example 6: LLC With State Law Nonrecourse Liability
AB LLC
A B
Y Third-
Party
Lender
$500,000 nonrecourse
loan to AB LLC, secured
solely by AB LLC’s office
building
• Is the loan treated as a recourse or
nonrecourse loan under §1001?
How about §752?
• How is the loan from Y allocated to
A and B?
• Assume that the loan proceeds
from Y are used to purchase an
office building, which is AB’s only
asset. How is depreciation from the
office building allocated to A and B?
• What are the tax implications if AB
Partnership transfers the office to Y
in satisfaction of the $500,000
loan? Assume the building has a
FMV of $400,000 and a tax basis
of $200,000 at the time of the
transfer.
50%
member 50%
member
53
Example 6: Answer
I. Is the loan treated as a recourse or nonrecourse loan under
1001? How about 752?
A. It is nonrecourse under both
1001.
B. The debt is nonrecourse debt for purposes of
752.
II. How is the loan from Y allocated to A and B?
A. The debt is partnership nonrecourse debt. Partnership nonrecourse
liabilities are generally allocated to the partners according to their
interests in partnership profits. See Reg.
1.752-3.
III. Assume that the loan proceeds from Y are used to purchase an office building,
which is AB’s only asset. How is depreciation from the office building allocated
to A and B?
A. Subject to the safe harbor requirements pursuant to Reg.
1.704-2(e),
nonrecourse deductions, including depreciation, are generally allocated in
proportion to the members’ interests in the partnership.
54
Example 6: Answer (Continued)
IV. What are the tax implications if AB Partnership transfers the office to Y in
satisfaction of the $500,000 loan? Assume the building has a FMV of $400,000
and a tax basis of $200,000 at the time of the transfer.
A. $300,000 gain from sale or exchange of the office – A transfer of property
that secures a nonrecourse loan to the creditor in satisfaction of the
loan results in a sale or exchange to the debtor under
1001, equal to
the difference between the debtor’s adjusted basis in the property and
the adjusted issue price of the debt.
B. The gain would generally be allocated to A and B in accordance with
their interests in partnership profits, subject to the partnership
minimum gain chargeback provisions under Reg. 1.704-2(f).
55
Example 7: LLC With State Law Recourse Liability
AB LLC
A B
Y Third-
Party
Lender
$500,000 recourse loan to
AB LLC, secured by all of
AB LLC’s assets
• Is the loan treated as a recourse or
nonrecourse loan under §1001?
How about §752?
• How is the loan from Y allocated to
A and B?
• Assume that the loan proceeds
from Y are used to purchase an
office building, which is AB’s only
asset. How is depreciation from the
office building allocated to A and B?
• What are the tax implications if AB
Partnership transfers the office to Y
in satisfaction of the $500,000
loan? Assume the building has a
FMV of $400,000 and a tax basis
of $200,000 at the time of the
transfer.
50%
member 50%
member
56
Example 7: Answer
I. Is the loan treated as a recourse or nonrecourse loan under
1001? How about 752?
A. The loan is recourse for purposes of
1001.
B. The loan is nonrecourse debt for purposes of
752.
II. How is the loan from Y allocated to A and B?
A. The loan is partnership nonrecourse debt. A partnership nonrecourse
liability is generally allocated in accordance with the members’ interests in
partnership profits. See Reg.
1.752-3.
III. Assume that the loan proceeds from Y are used to purchase an office building,
which is AB’s only asset. How is depreciation from the office building allocated
to A and B?
A. Subject to the safe harbor requirements pursuant to Reg.
1.704-2(e),
partnership nonrecourse deductions, including depreciation, are allocated
in proportion to the members’ interests in the LLC.
57
Example 7: Answer (Continued)
IV. What are the tax implications if AB Partnership transfers the office to Y in
satisfaction of the $500,000 loan? Assume the building has a FMV of $400,000
and a tax basis of $200,000 at the time of the transfer.
A. $200,000 gain from sale or exchange of the office – this is the difference
between AB Partnership’s tax basis and the FMV of the building and land at
the time of the transfer. (
1001)
1. The gain from the sale or exchange will generally be allocated to A and B in
accordance with their profits’ interests in the partnership, subject to the
partnership minimum gain chargeback provisions under Reg.
1.704-2(f).
B. $100,000 CODI – this is the difference between the amount of the forgiven
debt and the FMV of the building and land.
1. This income will generally be allocated to A and B in accordance with their
profits interests in the partnership, subject to the partnership minimum gain
chargeback provisions under Reg.
1.704-2(f).
58
Example 8: LLC With State Law Nonrecourse Liability Guaranteed By Member
AB LLC
A B
Y Third-
Party
Lender
$500,000 nonrecourse loan
to AB LLC, secured solely by
AB LLC’s office building. A
guarantees full repayment of
the loan.
• Is the loan treated as a recourse or
nonrecourse loan under §1001?
How about §752?
• How is the loan from Y allocated to
A and B?
• Assume that the loan proceeds
from Y are used to purchase an
office building, which is AB’s only
asset. How is depreciation from the
office building allocated to A and B?
• What are the tax implications if AB
Partnership transfers the office to Y
in satisfaction of the $500,000
loan? Assume the building has a
FMV of $400,000 and a tax basis
of $200,000 at the time of the
transfer.
50%
member 50%
member
59
Example 8: Answer
I. Is the loan treated as a recourse or nonrecourse loan under
1001? How about 752?
A. The loan is nonrecourse for purposes of
1001.
B. The loan is recourse debt for purposes of
752.
II. How is the loan from Y allocated to A and B?
A. The loan is partner nonrecourse debt to A because A bears the risk of loss
for a partnership nonrecourse liability. A partner nonrecourse liability is
allocated to the partner who bears the economic risk of loss, which is A.
III. Assume that the loan proceeds from Y are used to purchase an office building,
which is AB’s only asset. How is depreciation from the office building allocated
to A and B?
A. Partner nonrecourse deductions, including depreciation, are allocated to
the partner who bears the economic risk of loss. Thus, depreciation is
allocated 100% to A.
60
Example 8: Answer (Continued)
IV. What are the tax implications if AB Partnership transfers the office to Y in
satisfaction of the $500,000 loan? Assume the building has a FMV of $400,000
and a tax basis of $200,000 at the time of the transfer.
A. $300,000 gain from sale or exchange of the office – A transfer of property
that secures a nonrecourse loan to the creditor in satisfaction of the loan
results in a sale or exchange to the debtor under
1001, equal to the
difference between the debtor’s adjusted basis in the property and the
adjusted issue price of the debt.
B. The gain is subject to the partner minimum gain chargeback rules under Reg. 1.704-2. Thus, the gain would be allocated 100% to A.
62
Example 9: LLC With State Law Recourse Liability Guaranteed By Member
AB LLC
A B
Y Third-
Party
Lender
$500,000 recourse loan to
AB LLC; A guarantees full
repayment of the loan.
• Is the loan treated as a recourse or
nonrecourse loan under §1001?
How about §752?
• How is the loan from Y allocated to
A and B?
• Assume that the loan proceeds
from Y are used to purchase an
office building, which is AB’s only
asset. How is depreciation from the
office building allocated to A and B?
• What are the tax implications if AB
Partnership transfers the office to Y
in satisfaction of the $500,000
loan? Assume the building has a
FMV of $400,000 and a tax basis
of $200,000 at the time of the
transfer.
50%
member 50%
member
63
Example 9: Answer
I. Is the loan treated as a recourse or nonrecourse loan under
1001? How about 752?
A. The loan is recourse for purposes of
1001.
B. The loan is recourse debt for purposes of
752.
II. How is the loan from Y allocated to A and B?
A. A recourse debt is allocated to the partner who bears the economic risk of
loss. Thus, the liability is allocated 100% to A.
III. Assume that the loan proceeds from Y are used to purchase an office building,
which is AB’s only asset. How is depreciation from the office building allocated
to A and B?
A. Provided the allocation has substantial economic effect, depreciation is
allocated in accordance with the partnership agreement.
64
Example 9: Answer (Continued)
IV. What are the tax implications if AB Partnership transfers the office to Y in
satisfaction of the $500,000 loan? Assume the building has a FMV of $400,000
and a tax basis of $200,000 at the time of the transfer.
A. $200,000 gain from sale or exchange of the office – this is the difference
between AB Partnership’s tax basis and the FMV of the building and land at
the time of the transfer. (
1001).
1. The gain would be allocated to A and B in accordance with the partnership
agreement provided such allocation has substantial economic effect.
B. $100,000 CODI – this is the difference between the amount of the forgiven
debt and the FMV of the building and land.
1. The income would be allocated to A and B in accordance with the partnership
agreement provided such allocation has substantial economic effect.
65
Example 10: Limited Partnership With Wholly Owned LLC With State Law Recourse Liability
AB LP
A B
Y Third-
Party
Lender
$500,000 recourse loan to
XY LLC
• Is the loan treated as a recourse or
nonrecourse loan under §1001?
How about §752?
• How is the loan from Y allocated to
A and B?
• Assume that the loan proceeds
from Y are used to purchase an
office building, which is AB’s only
asset. How is depreciation from the
office building allocated to A and B?
• What are the tax implications if AB
Partnership transfers the office to Y
in satisfaction of the $500,000
loan? Assume the building has a
FMV of $400,000 and a tax basis
of $200,000 at the time of the
transfer.
50%
member
50%
member
WX
LLC
100%
66
Example 10: Answer
I. Is the loan treated as a recourse or nonrecourse loan under
1001? How about 752?
A. The characterization of the liability for purposes of
1001 is unclear. For
state law purposes, the loan is recourse to WX LLC, but nonrecourse to AB,
LP.
B. The loan is nonrecourse debt for purposes of
752.
II. How is the loan from Y allocated to A and B?
A. The loan is partnership nonrecourse debt. A partnership nonrecourse
liability is generally allocated in accordance with the members’ interests in
partnership profits. See Reg.
1.752-3.
67
Example 10: Answer (Continued)
III. Assume that the loan proceeds from Y are used to purchase an office building,
which is AB’s only asset. How is depreciation from the office building allocated
to A and B?
A. Subject to the safe harbor requirements pursuant to Reg.
1.704-2(e),
partnership nonrecourse deductions, including depreciation, are allocated
in proportion to the members’ interests in the LLC.
68
Example 10: Answer (Continued)
IV. What are the tax implications if AB Partnership transfers the office to Y in
satisfaction of the $500,000 loan? Assume the building has a FMV of $400,000
and a tax basis of $200,000 at the time of the transfer.
A. The answer will depend on how the liability is treated for purposes of 1001.
69
Example 10: Answer (Continued)
B. The gain is taxed as follows if the liability is treated as recourse debt for
purposes of
1001:
1. $200,000 gain from sale or exchange of the office – this is the difference
between AB Partnership’s tax basis and the FMV of the building and land at the
time of the transfer. (
1001).
a. Because the debt is treated as partnership nonrecourse debt for purposes
of
752, the gain from the sale or exchange will generally be allocated to A
and B in accordance with their profits’ interests in the partnership, subject
to the partnership minimum gain chargeback provisions under Reg.
1.704-
2(f).
2. $100,000 CODI – this is the difference between the amount of the forgiven debt
and the FMV of the building and land.
a. The income will generally be allocated to A and B in accordance with their
profits’ interests in the partnership, subject to the partnership minimum
gain chargeback provisions under Reg.
1.704-2(f).
70
Example 10: Answer (Continued)
C. The gain is taxed as follows if the liability is treated as nonrecourse debt
for purposes of
1001:
1. $300,000 gain from sale or exchange of the office – A transfer of
property that secures a nonrecourse loan to the creditor in
satisfaction of the loan results in a sale or exchange to the debtor
under
1001, equal to the difference between the debtor’s adjusted
basis in the property and the adjusted issue price of the debt.
a. Because the debt is treated as partnership nonrecourse debt for purposes
of
752, the gain from the sale or exchange will generally be allocated to A
and B in accordance with their profits’ interests in the partnership, subject
to the partnership minimum gain chargeback provisions under Reg.
1.704-
2(f).
72
Sect. 465 At-Risk Amount
I. A taxpayer is considered at risk for an activity with respect to
amounts borrowed with respect to such activity. (
465(b)(1)(B))
II. Amounts borrowed for use in an activity include:
A. Debt for which the taxpayer is personally liable for
repayment, and
B. Debt for which the taxpayer has pledged property (other
than property used in the activity) as security for the
borrowed amount.
1. Amount at risk is limited to the net FMV of the collateral.
73
Sect. 465 At-Risk Amount (Cont.)
I. Taxpayer must be primarily liable on the debt.
A. Guarantees do not increase the taxpayer’s amount at risk
until the taxpayer repays the creditor for the amount
borrowed, and the taxpayer has no remaining legal rights
against the primary obligor. (Prop. Reg.
1.465-6(d))
II. Amounts borrowed for use in an activity do not include:
A. Amounts borrowed from any person who has an interest
(other than as a creditor) in the activity
B. Amounts borrowed from a person related to any person who
has an interest (other than as a creditor) in the activity
(other than the taxpayer)
74
Sect. 465 At-Risk Amount (Cont.)
I. Only “qualified” nonrecourse debts are included in at-risk
amount:
A. Borrowed with respect to activity of holding real estate,
and secured by real estate;
B. Borrowed from a lender in the business of lending money
and who has no interest in the activity in which the funds
are used; and
C. Not convertible into stock or securities.
75
Example: Basis And At-Risk Limitations
Susan is a 10% owner in ABC LLC, which has elected to be treated as
a partnership for federal income tax purposes. Her tax basis in the
LLC is $25,000, consisting of a $10,000 capital contribution and
$15,000 of non-qualified, nonrecourse debt. For 2011, Susan’s
distributive share of the LLC’s loss is ($32,000).
76
Example: Basis And At-Risk Limitations (Cont.)
2011 Basis Limitation At-Risk Limitation
Capital contribution 10,000 10,000
Non-qualified, non-
recourse debt
15,000 - 0 -
Loss allowed for 2011 (25,000) (10,000)
Balance – 12/31/11 - 0 - - 0 -
Carryover to 2012 (7,000) (15,000)
77
Example: Basis And At-Risk Limitations (Cont.)
2012 Basis Limitation At-Risk Limitation
LLC income for 2012 10,000
Loss carryover from 2011 (7,000)
Net income reported for
2012
3,000 3,000
Loss carryover from 2011 - 0 - (3,000)
Balance -12/31/12 3,000 - 0 -
Carryover to 2013 - 0 - (12,000)
ABC, LLC has positive income for 2012. Susan’s distributive
share is $10,000.
78
Example: Basis And At-Risk Limitations (Cont.)
Susan sells her interest in ABC, LLC in 2013 for $8,000 cash, plus
assumption of her $15,000 share of the LLC’s non-qualified, non-
recourse debt.
Susan will recognize a $20,000 gain. This $20,000 gain will trigger
release of the ($12,000)
465 carryforward from 2012.
79
Treatment Of Partnership Liabilities For Partnership Income Tax Purposes
Circular 230 Disclosure
These materials are intended for internal discussion purposes only. To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this communication is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or any other state or local law, or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.