Allocation of Liabilities

1. Allocation of Liabilities Section 752

2. Effect of Liabilities on Basis Section 752(a) - As a partner’s percentage of liabilities goes up – deemed cash contribution Section 752(b) - As a partner’s percentage of liabilities goes down – deemed cash distribution

3. Partnership liabilities: definition Section 752 liabilities are partnership obligations that either: Create or increase the asset basis Give rise to an immediate deduction Give rise to a nondeductible and noncapitalized expense Section 752 divides liabilities into recourse and nonrecourse liabilities Treas. Reg. §1.752-7 liabilities are obligations that are not §752 liabilities. Show SL, Partnership liabilities – definition. Review the content on the slide, emphasizing the important points. Treas. Reg. §1.752-1(a)(4)’s definition of §752 liabilities replaces guidance under Rev. Rul. 88-77. It is effective for liabilities incurred or assumed by a partnership after June 24, 2003. An obligation is defined by Treas. Reg. §1.752-1(a)(4) as a fixed or contingent obligation to make a payment without regard to whether the obligation is taken into account for purposes of the Code. Obligations are related to debt, environmental, tort, contract, pension, short sales, and derivative financial instruments such as options forward contacts and futures contracts. No liability is created unless the partnership is currently obligated to repay funds or other property advanced. Specifically, a partnership obligation which is subject to “contingencies that make it unlikely that the obligation will ever be discharged,” is disregarded for tax purposes. Treasury issued regulation 1.752-7[i] that deals with the partnership’s assumption of contingent liabilities from a contributing partner. The regulation provides rules to prevent the duplication and acceleration of loss through the assumption by a partnership of certain liabilities from a partner. The rules are similar to those for corporations contained in section IRC Section 358(h). However, regulation 1.752-7 does not contain the “substantially all” exception that is available to corporations. in IRC Section 358(h). This regulation applies to certain fixed or contingent obligations to make payments that require payments are not described in section 1.752-1(a)(1). The section 1.752-7 liability is treated as having a built-in loss equal to the amount of the liability at the time of its assumption by the partnership. When the liability is satisfied, the deduction for the built-in loss is allocated to the partner who contributed the liability. Regulation 1.752-7 applies to contingent liabilities assumed on or after June 24, 2003. Example of Treas. Reg. §1.752-7 liability: P contributes an asset with an FMV equal to its basis plus contractual obligation for which economic performance has not occurred. The partnership takes the position that the obligation is not a §752 liability and has no effect on P’s basis. P sells its partnership interest prior to economic performance. Since FMV is less than P’s basis due to the obligation, P gets a loss, but deduction at economic performance stays with the partnership to be allocated to other partners (such as duplication of loss/deduction). Show SL, Partnership liabilities – definition. Review the content on the slide, emphasizing the important points. Treas. Reg. §1.752-1(a)(4)’s definition of §752 liabilities replaces guidance under Rev. Rul. 88-77. It is effective for liabilities incurred or assumed by a partnership after June 24, 2003. An obligation is defined by Treas. Reg. §1.752-1(a)(4) as a fixed or contingent obligation to make a payment without regard to whether the obligation is taken into account for purposes of the Code. Obligations are related to debt, environmental, tort, contract, pension, short sales, and derivative financial instruments such as options forward contacts and futures contracts. No liability is created unless the partnership is currently obligated to repay funds or other property advanced. Specifically, a partnership obligation which is subject to “contingencies that make it unlikely that the obligation will ever be discharged,” is disregarded for tax purposes. Treasury issued regulation 1.752-7[i] that deals with the partnership’s assumption of contingent liabilities from a contributing partner. The regulation provides rules to prevent the duplication and acceleration of loss through the assumption by a partnership of certain liabilities from a partner. The rules are similar to those for corporations contained in section IRC Section 358(h). However, regulation 1.752-7 does not contain the “substantially all” exception that is available to corporations. in IRC Section 358(h). This regulation applies to certain fixed or contingent obligations to make payments that require payments are not described in section 1.752-1(a)(1). The section 1.752-7 liability is treated as having a built-in loss equal to the amount of the liability at the time of its assumption by the partnership. When the liability is satisfied, the deduction for the built-in loss is allocated to the partner who contributed the liability. Regulation 1.752-7 applies to contingent liabilities assumed on or after June 24, 2003.

4. How are liabilities allocated? Regulations under 1.752 address this issue The ultimate goal is to allocate debt to the person who is “ultimately liable” to pay the debt

5. Regulation 1.752-1 The regulations broadened the coverage of Section 752 from partner to partner and related parties. Related parties are defined under Section 267(b) and Section 707(b)(1) – but you must change the percentage to 80%.

6. Regulation 1.752-1 Reg. 1.752-1(e) allows the netting method for increases and decreased in liabilities in the same transaction. Reg. 1.752-1(i) separates liabilities between recourse and nonrecourse liabilities.

7. How are partnership liabilities allocated? Recourse liabilities: partner’s economic risk of loss (EROL) Partner’s required payments or contributions upon constructive partnership liquidation Nonrecourse liabilities: partner’s interest in partnership profits Partner’s share of three tiers of partnership profits Show SL, How are partnership liabilities shared? Review the content on the slide, emphasizing the important points. Partnership recourse liabilities are allocated according to a partner’s economic risk of loss if the liabilities were to become due and payable and, assuming that the partnership assets were worthless, the partner was obligated to satisfy all or a portion of the liabilities. Treas. Reg. §1.752-2(a). A partner’s obligation with respect to recourse liabilities is evidenced by a requirement to make a payment to any person, or a contribution to the partnership, with respect to the liability. Application: Typically, general partners are allocated the partnership’s recourse liabilities since they usually have unconditional deficit capital account restoration obligations under the terms of the partnership agreement or liability to the creditors under state law. Thus, if the partnership assets were to become worthless, the general partners would be required to satisfy the indebtedness through payment to the creditors or contributions to the partnership. However, limited partners also might be allocated partnership recourse liabilities if they bear an economic risk of loss with respect to the liability. In general, limited partners will bear an economic risk of loss if they have an unconditional obligation to make a payment to the creditor (such as a guarantee of the indebtedness without right of subrogation) or a contribution to the partnership if the partnership agreement contains a provision that requires the limited partners to restore a deficit balance in their capital accounts coupled with a qualified income offset provision. Partnership nonrecourse liabilities are allocated according a tiered system, culminating in a partner’s interest in partnership profits (or share of partnership nonrecourse deductions. Treas. Reg. §1.752-3(a). Allocations are based on profits shares, since no partner is personally liable for repayment, and liabilities will be paid only from shares of partnership profits (or partnership minimum gain). Application: Typically, nonrecourse liabilities are allocated to general and limited partners based on the terms of the partnership agreement regarding the partners’ interests in the partnership profits. The regulations use a three-tier profit-sharing approach when allocating the nonrecourse liabilities in which a partner’s share of the liabilities is the aggregate of the partner’s share of profits in each of the three tiers. Show SL, How are partnership liabilities shared? Review the content on the slide, emphasizing the important points. Partnership recourse liabilities are allocated according to a partner’s economic risk of loss if the liabilities were to become due and payable and, assuming that the partnership assets were worthless, the partner was obligated to satisfy all or a portion of the liabilities. Treas. Reg. §1.752-2(a). A partner’s obligation with respect to recourse liabilities is evidenced by a requirement to make a payment to any person, or a contribution to the partnership, with respect to the liability. Application: Typically, general partners are allocated the partnership’s recourse liabilities since they usually have unconditional deficit capital account restoration obligations under the terms of the partnership agreement or liability to the creditors under state law. Thus, if the partnership assets were to become worthless, the general partners would be required to satisfy the indebtedness through payment to the creditors or contributions to the partnership. However, limited partners also might be allocated partnership recourse liabilities if they bear an economic risk of loss with respect to the liability. In general, limited partners will bear an economic risk of loss if they have an unconditional obligation to make a payment to the creditor (such as a guarantee of the indebtedness without right of subrogation) or a contribution to the partnership if the partnership agreement contains a provision that requires the limited partners to restore a deficit balance in their capital accounts coupled with a qualified income offset provision. Partnership nonrecourse liabilities are allocated according a tiered system, culminating in a partner’s interest in partnership profits (or share of partnership nonrecourse deductions. Treas. Reg. §1.752-3(a). Allocations are based on profits shares, since no partner is personally liable for repayment, and liabilities will be paid only from shares of partnership profits (or partnership minimum gain). Application: Typically, nonrecourse liabilities are allocated to general and limited partners based on the terms of the partnership agreement regarding the partners’ interests in the partnership profits. The regulations use a three-tier profit-sharing approach when allocating the nonrecourse liabilities in which a partner’s share of the liabilities is the aggregate of the partner’s share of profits in each of the three tiers.

8. Change in share of partnership liabilities Partnership incurs, refinances or liquidates liability New partner is admitted to partnership Partner contributes asset to partnership, or receives distribution of asset from partnership, encumbered by liability Partnership sells assets encumbered by liability Partnership recourse liability converted to nonrecourse liability or vice versa Partner or related person guarantees partnership liability Entity conversion (general partnership to limited partnership or LLC, or vice versa) Show SL, Change in share of partnership liabilities. Review the content on the slide, emphasizing the important points. Changes in the partners’ shares of partnership liabilities are commonly referred to as liability shifts. Under Treas. Reg. §1.752-4(d), a partner’s share of partnership liabilities must be determined whenever necessary to determine the tax liability of the partner or any other person. In most cases, this will be at the end of the partnership tax year (to determine the tax basis of partnership interest for loss deduction under §704(d) or gain recognition under §731(a) if cash distributions of profit share during the year). The IRS held in Rev. Rul. 94-4, 1994-1 C.B. 195 that a deemed distribution of money due to a reduction in a partner’s share of partnership liabilities is treated as an advance of money to the distributee partner, to the extent of that partner’s share of partnership profits for the partnership tax year of distribution, which is accounted for on the last day of the partnership’s tax year. (See also Richardson v. Comm., 76 T.C. 512 (1981), which held that the old partners need not re-determine their adjusted tax basis in their partnership interests upon the admission of a new partner until the end of the partnership’s tax year.) Show SL, Change in share of partnership liabilities. Review the content on the slide, emphasizing the important points. Changes in the partners’ shares of partnership liabilities are commonly referred to as liability shifts. Under Treas. Reg. §1.752-4(d), a partner’s share of partnership liabilities must be determined whenever necessary to determine the tax liability of the partner or any other person. In most cases, this will be at the end of the partnership tax year (to determine the tax basis of partnership interest for loss deduction under §704(d) or gain recognition under §731(a) if cash distributions of profit share during the year). The IRS held in Rev. Rul. 94-4, 1994-1 C.B. 195 that a deemed distribution of money due to a reduction in a partner’s share of partnership liabilities is treated as an advance of money to the distributee partner, to the extent of that partner’s share of partnership profits for the partnership tax year of distribution, which is accounted for on the last day of the partnership’s tax year. (See also Richardson v. Comm., 76 T.C. 512 (1981), which held that the old partners need not re-determine their adjusted tax basis in their partnership interests upon the admission of a new partner until the end of the partnership’s tax year.)

9. Change in share of partnership example On 15 October 20X9, ABC Partnership, which uses a calendar year, admits new Partner D, who receives a 25% partnership interest. Partner C, whose partnership interest decreased from 35% to 25%, had an outside basis of $10,000 on 15 October 20X9. If the partnership has a $25,000 nonrecourse liability and C’s profit share for the 2009 year-end is $500, what are the tax consequences to Partner C resulting from the admittance of new Partner D? How would this change if C’s basis was only $1,000 at 10/15? Show SL, Change in share of partnership example. Review the example with the group. Tell the participants they have a few minutes to work through the example, and then ask for a participant to provide the correct answer. Show SL, Change in share of partnership example. Review the example with the group. Tell the participants they have a few minutes to work through the example, and then ask for a participant to provide the correct answer.

10. Example A limited partnership is formed to construct office condos. The general partner’s interest is 1%, and the limited partners’ interests are 99%. The general partner is solely liable for $900 construction loan financing. On 1 January 20X9, 80% tenant occupancy is reached, and the construction loan is converted to mortgage financing secured by the building, which releases the general partner from liability. On 1 January 20X9, the partnership’s book-tax balance sheet is assets, $900; mortgage debt, $900; general partner capital account, $(50); and limited partner capital accounts, $50. What are the tax consequences to the partners on 1 January 20X9? Show SL, Example. Review the example and discuss the solution with the group. The loan converts from a recourse partnership liability to a nonrecourse liability. Before the conversion, the construction loan was a recourse liability that was 100% allocable to the general partner. Upon conversion, the mortgage is allocated to the partners according to their interests in partnership profits. The limited partners’ tax bases for their partnership interests are increased. The general partner’s tax basis is decreased. Show SL, Example. Review the example and discuss the solution with the group. The loan converts from a recourse partnership liability to a nonrecourse liability. Before the conversion, the construction loan was a recourse liability that was 100% allocable to the general partner. Upon conversion, the mortgage is allocated to the partners according to their interests in partnership profits. The limited partners’ tax bases for their partnership interests are increased. The general partner’s tax basis is decreased.

11. Recourse liability: definition A recourse liability is any liability for which any partner (or person related to a partner) bears the economic risk of loss for the liability. Treas. Reg. §1.752-1(a)(1) Show SL, Recourse liability – definition. Review the content on the slide, emphasizing the important points. A recourse liability is any liability for which any partner (or person related to a partner) bears the economic risk of loss for the liability. A partner’s share of recourse liabilities equals the portion, if any, of the economic risk of loss for such liability that is borne by that partner or persons related to such partner. Treas. Reg. §1.752-1(a)(1). Mention to participants that recourse and nonrecourse liability classification for §752 purposes might be different than for §1001 purposes. Show SL, Recourse liability – definition. Review the content on the slide, emphasizing the important points. A recourse liability is any liability for which any partner (or person related to a partner) bears the economic risk of loss for the liability. A partner’s share of recourse liabilities equals the portion, if any, of the economic risk of loss for such liability that is borne by that partner or persons related to such partner. Treas. Reg. §1.752-1(a)(1). Mention to participants that recourse and nonrecourse liability classification for §752 purposes might be different than for §1001 purposes.

12. Recourse liabilities (economic risk of loss) Recourse liabilities are allocated to partners based on their share of the economic risk of loss Generally, a partner bears economic risk of loss if, upon constructive liquidation of the partnership, the partner (or a related person) is obligated to make either: A payment to any person A contribution to the partnership Show SL, Recourse liabilities (economic risk of loss). Review the content on the slide, emphasizing the important points. The §752 regulations allocate recourse liabilities among partners in the manner in which they share the economic risk of loss, considering related parties, guarantees, indemnity agreements, assumptions, and other reimbursement techniques. In other words, if the partnership were to liquidate, who would ultimately be responsible for securing the payment of the debt? The ultimate obligor would be the person who gets the benefit (basis) of the liability. Show SL, Recourse liabilities (economic risk of loss). Review the content on the slide, emphasizing the important points. The §752 regulations allocate recourse liabilities among partners in the manner in which they share the economic risk of loss, considering related parties, guarantees, indemnity agreements, assumptions, and other reimbursement techniques. In other words, if the partnership were to liquidate, who would ultimately be responsible for securing the payment of the debt? The ultimate obligor would be the person who gets the benefit (basis) of the liability.

13. Allocation of recourse liabilities Treas. Reg. §1.752-2(b)(1) uses a constructive liquidation to allocate recourse liabilities On the determination date, the following events are deemed to occur: Assets become worthless Including cash Excluding specially pledged assets Assets are deemed sold for no consideration Show SL, Constructive liquidation. Review the content on the slide, emphasizing the important points. Treas. Reg. §1.752-2(b)(1) The regulations adopted constructive (deemed) liquidation as a convention for determining a partner’s economic risk of loss at the various times necessary for establishing a partner’s share of partnership liabilities. See Treas. Reg. §1.752-2(b)(1). Under the regulations, the following events are deemed to occur when a partnership constructively liquidates. All of the assets of the partnership become worthless, other than those treated as being contributed to the partnership to secure payment of a liability and the partnership’s rights to require partners or persons related to partners to make contributions to the partnership or to make payments to creditors. All liabilities of the partnership become due and payable in full because of the partnership’s failure to make the payments required with respect to such liabilities. Show SL, Constructive liquidation. Review the content on the slide, emphasizing the important points. Treas. Reg. §1.752-2(b)(1) The regulations adopted constructive (deemed) liquidation as a convention for determining a partner’s economic risk of loss at the various times necessary for establishing a partner’s share of partnership liabilities. See Treas. Reg. §1.752-2(b)(1). Under the regulations, the following events are deemed to occur when a partnership constructively liquidates. All of the assets of the partnership become worthless, other than those treated as being contributed to the partnership to secure payment of a liability and the partnership’s rights to require partners or persons related to partners to make contributions to the partnership or to make payments to creditors. All liabilities of the partnership become due and payable in full because of the partnership’s failure to make the payments required with respect to such liabilities.

14. Allocation of recourse liabilities (cont.) All assets securing nonrecourse debt are transferred to creditors for no consideration other than relief of the nonrecourse debt. Gain or loss recognized on the deemed asset dispositions are allocated to the partners. Partners and related parties fulfill their obligations to the partnership and creditors. Show SL, Constructive liquidation (cont.). Review the content on the slide, emphasizing the important points. All assets (whether or not worthless) are transferred to their respective lienholders for no consideration other than relief of nonrecourse indebtedness, and any remaining assets are disposed of in fully taxable transactions for no consideration. The partnership allocates any items of income, gain, loss, deduction, and credit for the partnership taxable year ending on the date of the liquidation among the partners in accordance with the partnership agreement and liquidates the partners’ interests in the partnership. Following the deemed liquidation described below, the partners (and persons related to partners) are deemed to then fulfill their obligations to the partnership and creditors to determine to what extent each partner will be deemed to ultimately bear the economic risk of loss for each liability of the partnership. The partnership liquidates. Show SL, Constructive liquidation (cont.). Review the content on the slide, emphasizing the important points. All assets (whether or not worthless) are transferred to their respective lienholders for no consideration other than relief of nonrecourse indebtedness, and any remaining assets are disposed of in fully taxable transactions for no consideration. The partnership allocates any items of income, gain, loss, deduction, and credit for the partnership taxable year ending on the date of the liquidation among the partners in accordance with the partnership agreement and liquidates the partners’ interests in the partnership. Following the deemed liquidation described below, the partners (and persons related to partners) are deemed to then fulfill their obligations to the partnership and creditors to determine to what extent each partner will be deemed to ultimately bear the economic risk of loss for each liability of the partnership. The partnership liquidates.

15. Allocation of Recourse Debt After the constructive liquidation the partner that must restore a negative capital account is the partner that the liability is allocated. Recourse debt is only allocated to general partners

16. Example Two partners each own 50% of the partnership. Both contribute $10 cash to the partnership and the partnership borrows $80. With the $100 the partnership now has it buys property. How do we allocate the debt to the partners.

17. Twist on the example In this case A is a 10% partner while B is a 90% partner. A contributed cash of $10 and B contributed property with a FMV of $90 and a basis of $10. The partnership borrows $80 to buy additional property. How is the debt allocated?

18. Partner’s ability to pay It is assumed that a partner will pay, regardless of partner’s net worth Anti-abuse rule - a partner’s obligation is disregarded if the facts and circumstances indicate a plan to avoid the obligation Show SL, Partner’s ability to pay. Review the content on the slide, emphasizing the important points. Satisfaction of Assumption If an obligation is recognized, the regulations assume that the obligor will discharge the obligation according to its terms upon constructive liquidation of the partnership. Therefore, a partner will be assumed to discharge an obligation, even if such partner’s net worth is less than the amount of the obligation, unless facts and circumstances indicate a plan to circumvent or avoid the obligation. Treas. Reg. §1.752-2(b)(6) and (j). Anti-Abuse Rule (Treas. Reg. §1.752-2(j)) A partner’s obligation to make a payment will be disregarded if the facts and circumstances indicate a plan to circumvent or avoid such obligation. New Regulations on Obligations of Disregarded Entities In 2006 the Treasury and IRS promulgated final regulations that limited the assumption that the obligor will discharge the obligation if the obligor holds its partnership interest through a disregarded entity. Treas. Reg. § 1.752-2(k). Show SL, Partner’s ability to pay. Review the content on the slide, emphasizing the important points. Satisfaction of Assumption If an obligation is recognized, the regulations assume that the obligor will discharge the obligation according to its terms upon constructive liquidation of the partnership. Therefore, a partner will be assumed to discharge an obligation, even if such partner’s net worth is less than the amount of the obligation, unless facts and circumstances indicate a plan to circumvent or avoid the obligation. Treas. Reg. §1.752-2(b)(6) and (j). Anti-Abuse Rule (Treas. Reg. §1.752-2(j)) A partner’s obligation to make a payment will be disregarded if the facts and circumstances indicate a plan to circumvent or avoid such obligation. New Regulations on Obligations of Disregarded Entities In 2006 the Treasury and IRS promulgated final regulations that limited the assumption that the obligor will discharge the obligation if the obligor holds its partnership interest through a disregarded entity. Treas. Reg. § 1.752-2(k).

19. Recourse liability guarantee example A general partner (G) and a limited partner (L) form an equal partnership, with each one contributing $100. G has a capital account deficit-restoration obligation but L does not. The partnership purchases an asset for $500 ($200 cash and $300 recourse loan from an unrelated bank). L guarantees payment of the loan. How will the partnership recourse liability be allocated? Show SL, Recourse liability guarantee example. Review the example with the group. Content continues on next SL.Show SL, Recourse liability guarantee example. Review the example with the group. Content continues on next SL.

20. Nonrecourse liability: definition A nonrecourse liability is any liability for which no partner (or person related to a partner) bears the economic risk of loss for the liability. Treas. Reg. §1.752-1(a)(2) Show SL, Nonrecourse liability – definition. Review the content on the slide, emphasizing the important points. A nonrecourse liability is any liability for which no partner (or person related to the partner) bears the economic risk of loss for the liability. A partner’s share of nonrecourse liabilities is generally determined by the manner in which the partners share partnership profits (or nonrecourse deductions), considering partnership minimum gain (under §704(b)) and §704(c) principles). Treas. Reg. §1.752-1(a)(2). Before discussing the rules for allocating recourse and nonrecourse partnership liabilities, explain to participants the relationship of allocations of partnership liabilities under §752 with allocations of partnership deductions and losses under §704. The §752 regulations attempt to correlate allocations of partnership liabilities with allocations of deductions funded by the liabilities under the §704(b) regulations. These regulations ensure that sufficient partnership interest basis (for §704(d) purposes) is available for the same partners who are allocated deductions that are financed by the liabilities. The correlation of the §752 regulations with the §704(b) regulations also ensures that partners who are allocated partnership liabilities for basis purposes will not recognize gain under §731 if the partnership liquidates the indebtedness or distributes any portion of the debt proceeds to the partners. Show SL, Nonrecourse liability – definition. Review the content on the slide, emphasizing the important points. A nonrecourse liability is any liability for which no partner (or person related to the partner) bears the economic risk of loss for the liability. A partner’s share of nonrecourse liabilities is generally determined by the manner in which the partners share partnership profits (or nonrecourse deductions), considering partnership minimum gain (under §704(b)) and §704(c) principles). Treas. Reg. §1.752-1(a)(2). Before discussing the rules for allocating recourse and nonrecourse partnership liabilities, explain to participants the relationship of allocations of partnership liabilities under §752 with allocations of partnership deductions and losses under §704. The §752 regulations attempt to correlate allocations of partnership liabilities with allocations of deductions funded by the liabilities under the §704(b) regulations. These regulations ensure that sufficient partnership interest basis (for §704(d) purposes) is available for the same partners who are allocated deductions that are financed by the liabilities. The correlation of the §752 regulations with the §704(b) regulations also ensures that partners who are allocated partnership liabilities for basis purposes will not recognize gain under §731 if the partnership liquidates the indebtedness or distributes any portion of the debt proceeds to the partners.

21. Nonrecourse liability guarantee example A general partner (G) and a limited partner (L) form an equal partnership, with each one contributing $100. G has a capital account deficit-restoration obligation, but L does not. The partnership purchases an asset for $500 ($200 cash and $300 nonrecourse loan from unrelated bank). L guarantees payment of the loan. How will the partnership nonrecourse liability be allocated? Show SL, Example. Review the example with the group. Show SL, Example. Review the example with the group.

22. Related persons Implements §§267(b) and 707(b)(1) rules except: 80% entity ownership is substituted for 50% Brothers and sisters are not family Special rules apply when a person is related to more than one partner Treas. Reg. §1.752-4 Show SL, Related persons. Review the content on the slide, emphasizing the important points. General Rule – A person will be considered to be related to a partner if that person and the partner bear a relationship described in §267(b) (without regard to §267(e)(1) or (f)(1)(A)) or §707(b)(1) with the following modifications (Treas. Reg. §1.752-4(b)): Eighty percent or more is substituted for more than 50%. Brothers and sisters are excluded from members of a person’s family. Persons Related to More Than One Partner – If a person is related to more than one partner, any obligations of such person will be considered those of the partner with the greatest percentage of related ownership in such person. When two or more related partners share the greatest equal percentage of related ownership, such partners will equally allocate the obligations, reimbursements, and liabilities of such person). Treas. Reg. §1.752-4(b)(2)(i). Multiple Relationships – If more than one of the relationships of §§267 and 707 would apply in a particular situation, the relationship yielding the highest percentage of related ownership is used. Natural persons are deemed to have a 100% share of related ownership with respect to each other. Treas. Reg. §1.752-4(b)(2)(i) and (ii). Related Partners – As a general rule, if two or more persons are related and both own (directly or indirectly) interests in the same partnership, then those partners will not be considered to be related persons for purposes of determining the economic risk of loss borne by each of them for the liabilities of the partnership. Treas. Reg. §1.752-4(b)(2)(iii). Show SL, Related persons. Review the content on the slide, emphasizing the important points. General Rule – A person will be considered to be related to a partner if that person and the partner bear a relationship described in §267(b) (without regard to §267(e)(1) or (f)(1)(A)) or §707(b)(1) with the following modifications (Treas. Reg. §1.752-4(b)): Eighty percent or more is substituted for more than 50%. Brothers and sisters are excluded from members of a person’s family. Persons Related to More Than One Partner – If a person is related to more than one partner, any obligations of such person will be considered those of the partner with the greatest percentage of related ownership in such person. When two or more related partners share the greatest equal percentage of related ownership, such partners will equally allocate the obligations, reimbursements, and liabilities of such person). Treas. Reg. §1.752-4(b)(2)(i). Multiple Relationships – If more than one of the relationships of §§267 and 707 would apply in a particular situation, the relationship yielding the highest percentage of related ownership is used. Natural persons are deemed to have a 100% share of related ownership with respect to each other. Treas. Reg. §1.752-4(b)(2)(i) and (ii). Related Partners – As a general rule, if two or more persons are related and both own (directly or indirectly) interests in the same partnership, then those partners will not be considered to be related persons for purposes of determining the economic risk of loss borne by each of them for the liabilities of the partnership. Treas. Reg. §1.752-4(b)(2)(iii).

23. Related persons (cont.) Partner-controlled lender rule Applies if principal purpose of nonrecourse loan to partnership (or guarantee of a partnership nonrecourse liability) is to avoid related-person rules and partner owns 20% or more of the lending entity Result: partner is treated as lender (or guarantor) in proportion to ownership interest in lending entity Show SL 101, Related persons (cont.). Review the content on the slide, emphasizing the important points. The partner-controlled lender rule is an anti-abuse rule designed to prevent avoidance of the partner-lender rule (such as an attempt to treat a partner’s or related person’s nonrecourse loan, or guarantee of a nonrecourse loan) to a partnership as an unrelated third-party nonrecourse liability so that a portion of the loan is allocated to other partners. Treas. Reg. §1.752-4(b)(2)(iv). Make sure that participants understand the concepts just discussed. Show SL 101, Related persons (cont.). Review the content on the slide, emphasizing the important points. The partner-controlled lender rule is an anti-abuse rule designed to prevent avoidance of the partner-lender rule (such as an attempt to treat a partner’s or related person’s nonrecourse loan, or guarantee of a nonrecourse loan) to a partnership as an unrelated third-party nonrecourse liability so that a portion of the loan is allocated to other partners. Treas. Reg. §1.752-4(b)(2)(iv). Make sure that participants understand the concepts just discussed.

24. Nonrecourse liabilities (profit sharing) The general thrust of the nonrecourse allocation rules is to allocate nonrecourse liabilities so as to reflect the manner in which the partners share partnership "profits." Partner’s share of partnership nonrecourse liabilities is sum of: Partner’s share of partnership minimum gain (Tier 1 profit-share allocations) Partner’s §704(c) minimum gain (Tier 2 profit-share allocations) Partner’s share of “excess” nonrecourse liabilities (Tier 3 profit-share allocations) Show SL, Nonrecourse liabilities (profit sharing). Review the content on the slide, emphasizing the important points. The §752 regulations use a three-tier profit-sharing structure to determine the partner’s interest in partnership profits. A partner’s share of the partnership’s nonrecourse liabilities is the aggregate of the partner’s share of profits in each of the three tiers based on applying the following order of prioritization: Tier 1 profit share, Tier 2 profit share, and Tier 3 profit share. Excess nonrecourse liabilities (Tier 3) are the portion of the partnership nonrecourse liabilities that were not allocated in Tiers 1 and 2. Show SL, Nonrecourse liabilities (profit sharing). Review the content on the slide, emphasizing the important points. The §752 regulations use a three-tier profit-sharing structure to determine the partner’s interest in partnership profits. A partner’s share of the partnership’s nonrecourse liabilities is the aggregate of the partner’s share of profits in each of the three tiers based on applying the following order of prioritization: Tier 1 profit share, Tier 2 profit share, and Tier 3 profit share. Excess nonrecourse liabilities (Tier 3) are the portion of the partnership nonrecourse liabilities that were not allocated in Tiers 1 and 2.

25. Share of partnership minimum gain (Tier 1) Partnership minimum gain equals nonrecourse debt principal greater than §704(b) book basis of secured property (computed separately for each nonrecourse liability [at end of each tax year], then aggregated) Partnership nonrecourse deductions equals Partner’s share of partnership minimum gain equals Show SL, Share of partnership minimum gain (tier 1). Review the content on the slide, emphasizing the important points. The partner’s shares of partnership minimum gain and nonrecourse deductions are determined by allocations specified in the partnership agreement. Partnership minimum gain is the amount of §704(b) book gain that the partnership would realize if the encumbered assets had been disposed of for no consideration other than satisfaction of the debt securing the assets (such as the amount of gain realized in a foreclosure). If encumbered property is subject to more than one liability and liabilities are of equal priority, then §704(b) book basis is allocated between liabilities based on principal balances. If liabilities are not of equal priority, then §704(b) book basis is allocated first to the highest-priority liability. Show SL, Share of partnership minimum gain (tier 1). Review the content on the slide, emphasizing the important points. The partner’s shares of partnership minimum gain and nonrecourse deductions are determined by allocations specified in the partnership agreement. Partnership minimum gain is the amount of §704(b) book gain that the partnership would realize if the encumbered assets had been disposed of for no consideration other than satisfaction of the debt securing the assets (such as the amount of gain realized in a foreclosure). If encumbered property is subject to more than one liability and liabilities are of equal priority, then §704(b) book basis is allocated between liabilities based on principal balances. If liabilities are not of equal priority, then §704(b) book basis is allocated first to the highest-priority liability.

26. Tier 1 allocations mini-case example On 1 January 20X9, Partnership owns one depreciable asset secured by a nonrecourse liability. The asset’s §704(b) book (and tax) basis is $800, nonrecourse debt principal is $700 and partner capital accounts are $100. Partnership’s 20X9 book (and tax) depreciation is $200. On 31 December 20X9, the asset basis is $600, nonrecourse debt principal is $700 and partner capital accounts are $(100). What is the amount of Partnership’s minimum gain? What portion of the $700 nonrecourse debt is allocated to Tier 1? Which partners will receive an allocation of the Tier 1 nonrecourse liability? Show SL, Tier 1 allocations mini case eample. Review the example with the group. Review the content on the slides, emphasizing the important points. Show SL, Tier 1 allocations mini case eample. Review the example with the group. Review the content on the slides, emphasizing the important points.

27. Share of partner §704(c) minimum gain (Tier 2) Partner §704(c) minimum gain (Tier 2) Section 704(c) gain (and reverse §704(c) gain resulting from §704(b) partnership revaluations) that would be allocated to contributing partner if all partnership assets secured by nonrecourse liabilities were disposed of in a taxable transaction in full satisfaction of liabilities with no other consideration Show SL, Share of partner §704(c) minimum gain (tier 2). Review the content on the slide, emphasizing the important points. The Tier 2 allocation of a partner’s §704(c) minimum gain to the contributing partner ensures that §731 gain (deemed cash distributions) will not be triggered to a contributing partner who contributes appreciated assets to a partnership that are encumbered by nonrecourse liabilities.Show SL, Share of partner §704(c) minimum gain (tier 2). Review the content on the slide, emphasizing the important points. The Tier 2 allocation of a partner’s §704(c) minimum gain to the contributing partner ensures that §731 gain (deemed cash distributions) will not be triggered to a contributing partner who contributes appreciated assets to a partnership that are encumbered by nonrecourse liabilities.

28. Tier 2 allocations mini-case example X contributes an asset to a partnership in exchange for a 20% partnership interest in a §721 transaction. The asset’s tax basis is $600 and its FMV is $1,000. The partnership takes the asset subject to X’s nonrecourse liability of $700 (secured by the asset), which is the partnership’s only nonrecourse liability. What is X’s §704(c) built-in gain? What is X’s §704(c) minimum gain (Tier 2 allocations)? How much of the debt is allocated to X, assuming no minimum gain under Tier 1? Show SL, Tier 2 allocations mini case example. Review the example with the group. Review the content on the slides, emphasizing the important points. Show SL, Tier 2 allocations mini case example. Review the example with the group. Review the content on the slides, emphasizing the important points.

29. Share of ‘excess’ nonrecourse liabilities (Tier 3) Allocation based on partner’s interest in partnership profits (economic arrangement of partners) Alternative methods Partnership agreement may specify interest in partnership profits if allocation is reasonably consistent with an allocation (having substantial economic effect) of some other significant item of partnership income or gain Allocate in same manner in which reasonably expected nonrecourse deductions will be allocated Priority to excess §704(c) gain or reverse §704(c) gain Flexibility – can change allocation method annually Show SL, Share of ‘excess’ nonrecourse liabilities (tier 3). Review the content on the slides, emphasizing the important points. The Tier 3 profit share of excess nonrecourse liabilities is generally based on the facts and circumstances concerning the economic arrangement of the partners. This is typically the profit-sharing ratios of the partners in the partnership agreement regarding the allocation of partnership income and gains. However, the §752 regulations also provide three alternative methods for allocating Tier 3 excess nonrecourse liabilities. The regulations permit flexibility by allowing the partnership to change its method of Tier 3 allocations each year. Instructor Note: The instructors should cover the three methods allowed by the regulations. Specifically discuss method #3 which allows the partnership to elect to allocate additional debt to a partner that contributed property that had a minimum gain. Note that if the partnership changes its method of Tier 3 allocations, it could result in changes in the partners’ shares of the liabilities that cause partnership interest basis shifts among the partners (increasing some partners’ basis, decreasing other partners’ basis, and possibly causing §731 gain recognition to the latter). Explain that if a partner contributes §704(c) property to the partnership, the §704(c) allocation method chosen by the partnership under Treas. Reg. §1.704-3 (traditional, curative, or remedial) will affect the determination of the partner’s §704(c) minimum gain in Tier 2 allocations (and the partner’s “excess” §704(c) gain in Tier 3 allocations). If the partnership elects to revalue its “book” assets and partner capital accounts under §704(b) upon the admission of a new partner (or other events that permit optional revaluations), the §704(c) allocation method chosen by the partnership under Treas. Reg. §1.704-3 (traditional, curative, or remedial) will affect the determination of the existing partners’ “excess” reverse §704(c) gain in Tier 3 allocations. The §752 regulations explicitly state that the excess §704(c) method of allocating liabilities is not applicable to determining partners’ shares of nonrecourse liabilities for purposes of the §707 disguised sales rules. Show SL, Share of ‘excess’ nonrecourse liabilities (tier 3). Review the content on the slides, emphasizing the important points. The Tier 3 profit share of excess nonrecourse liabilities is generally based on the facts and circumstances concerning the economic arrangement of the partners. This is typically the profit-sharing ratios of the partners in the partnership agreement regarding the allocation of partnership income and gains. However, the §752 regulations also provide three alternative methods for allocating Tier 3 excess nonrecourse liabilities. The regulations permit flexibility by allowing the partnership to change its method of Tier 3 allocations each year. Instructor Note: The instructors should cover the three methods allowed by the regulations. Specifically discuss method #3 which allows the partnership to elect to allocate additional debt to a partner that contributed property that had a minimum gain. Note that if the partnership changes its method of Tier 3 allocations, it could result in changes in the partners’ shares of the liabilities that cause partnership interest basis shifts among the partners (increasing some partners’ basis, decreasing other partners’ basis, and possibly causing §731 gain recognition to the latter). Explain that if a partner contributes §704(c) property to the partnership, the §704(c) allocation method chosen by the partnership under Treas. Reg. §1.704-3 (traditional, curative, or remedial) will affect the determination of the partner’s §704(c) minimum gain in Tier 2 allocations (and the partner’s “excess” §704(c) gain in Tier 3 allocations). If the partnership elects to revalue its “book” assets and partner capital accounts under §704(b) upon the admission of a new partner (or other events that permit optional revaluations), the §704(c) allocation method chosen by the partnership under Treas. Reg. §1.704-3 (traditional, curative, or remedial) will affect the determination of the existing partners’ “excess” reverse §704(c) gain in Tier 3 allocations. The §752 regulations explicitly state that the excess §704(c) method of allocating liabilities is not applicable to determining partners’ shares of nonrecourse liabilities for purposes of the §707 disguised sales rules.

30. How is nonrecourse debt allocated? New regulations allow partners to allocate additional Section 704(c) gain to contributing partners if the amount of debt they are allocated is reduced because of the Section 704(b) minimum gain layer Nonrecourse debt is allocated to both general and limited partners