On January 29, 2014, the Internal Revenue Service (“IRS”) and the Treasury Department issued proposed regulations (the “Proposed Regulations”) modifying the rules under Section 752 regarding the allocation of recourse and nonrecourse partnership liabilities and clarifying some aspects of the disguised sale rules of Section 707. The Proposed Regulations would make significant changes to the rules for allocating partnership liabilities among partners, including imposing a “net value” requirement on partners to whom liabilities are allocated and ignoring “bottom-dollar” guarantees in determining whether debt is recourse to the guarantor. In addition, the proposed regulations eliminate two of the alternative methods of allocating certain nonrecourse liabilities and replace those with a new method focusing on the partners’ relative liquidation values in the partnership. Although some aspects of the Proposed Regulations are helpful, the provisions regarding bottom-dollar guarantees and allocations of recourse and nonrecourse liabilities, if enacted as proposed, represent a significant change from current law and could create significant challenges for many common partnership structures.
Overview of Allocations of Recourse and Nonrecourse Liabilities under Current Law -
Section 752(a) treats any increase in a partner’s share of partnership liabilities as a contribution of money by such partner to the partnership. Conversely, a decrease in a partner’s share of partnership liabilities is treated as a distribution of money to the partner by the partnership. Partnership liabilities are subject to different allocation rules depending on whether they are treated as recourse or nonrecourse liabilities. In general, recourse liabilities are allocated to the partner(s) that bear the risk of loss while nonrecourse liabilities are allocated among all partners based on how they share profits.
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