A New Way to Unwind (Leveraged Partnership Structures): Treasury and IRS Propose Draconian Changes to the Partnership Liability Allocation Rules

On January 29, Treasury and the IRS issued proposed regulations that would dramatically change the manner in which partnership liabilities are allocated among the partnership’s partners under IRC § 752 (the Proposed Regulations). In brief, the allocation of liabilities under IRC § 752 impacts, among other things, a partner’s ability to receive cash distributions (including debt-financed distributions) from a partnership without the recognition of gain and a partner’s ability to utilize partnership losses. In view of the effects of IRC § 752, the changes contemplated by the Proposed Regulations have the potential to significantly alter the anticipated federal income tax consequences associated with partnerships that maintain even moderate amounts of leverage.

Sutherland Observation. As described in greater detail below, the Proposed Regulations offer what might best be described as a sea change in the rules governing the allocation of partnership liabilities among the partners of a partnership. On review, a not-so-subtle theme underlying the Proposed Regulations is that the ability of a partner to gain outside basis in the partner’s interest in the partnership on account of obligating itself to satisfy some portion of the partnership’s liabilities is somehow abusive. In succumbing to this shift in policy under IRC § 752, the Proposed Regulations dispense of an area of well-established law in one overly broad stroke.

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