Treasury Decision 9787

 

Treasury Decision 9787 – Final Regulations Under §707 Regarding Disguised Sales and §752 Regarding the Allocation of Excess Partnership Nonrecourse Liabilities to a Partner

On October 4, 2016, the Treasury Department and IRS released for publication final, temporary, and proposed regulations under sections 707 and 752. The final regulations substantially adopt 2014 proposed regulations with revisions to certain proposed rules in response to comments received. While the newly published regulations address several long standing partnership issues, at HLB Gross Collins, we believe the provisions that have the greatest potential to impact our clients relate to the allocation of partnership liabilities:

In determining if there is a disguised sales of property where there is a Debt-Financed Distribution and
In determining a partner’s share of recourse liabilities in the case of a Bottom Dollar Payment Obligation.

Disguised Sales
Generally, §721 provides that no taxable gain or loss shall be recognized to a partnership or any of its partners when a partner contributes property to the partnership in exchange for partnership interests. A disguised sale occurs when a partner contributes property to a partnership and in return receives any consideration other than partnership interests. Consideration can include cash distributions and relief of certain liabilities. Section 707 provides rules concerning disguised sales, and states that when such transactions occur, losses are disallowed and gains must be recognized as ordinary income. However, the final §707 regulations provide further guidance on the exceptions to the disguised sale rules.

One such exception is for Debt-Financed Distributions – If a partner transfers property to a partnership, the partnership incurs a liability, and all or a portion of the proceeds of that liability are traceable to a transfer of money or other consideration to the partner, the transfer of money or other consideration is considered a disguised sale only to the extent that the amount of money or the fair market value of other consideration exceeds the partner’s allocable share of the partnership liability. The final regulations state that partners must determine their share of any liability, whether recourse or nonrecourse based on the partner’s share of partnership profits.

In a case where the distribution of the proceeds from the liability is not made in the same proportion as the allocation of partnership profits, there would likely be a disguised sale. This is a change from prior practice where it was possible to avoid this outcome when the debt was allocated to the partner as recourse debt.

There are other exceptions including a distribution to reimburse preformation capital expenditures and a deemed distribution due to the partnership’s assumption of a qualified liability. These provisions were not materially changed from the proposed regulations.

Allocation of Partnership Liabilities in the case of Bottom Dollar Payment Obligations
Generally, §752 provides that any increase or decrease in a partner’s share of partnership liabilities is considered a contribution or distribution, respectively. Therefore, a partner’s basis increases and decreases when their share of partnership liabilities increases and decreases, respectively. In the past, special agreements known as bottom dollar payment obligations were used to change the character of liabilities from nonrecourse to recourse, and allocate the liabilities to a specific partner. In simple terms, a bottom dollar payment obligation is a guarantee where a partner agrees to repay partnership debt only if the creditor collects less than the guaranteed amount from the partnership.

The new §752 temporary regulations provide a special exception to the general rule above and state that bottom dollar payment obligations are not included in the guarantor partner’s share of partnership liabilities as a recourse liability. Instead, the debt is included in the excess nonrecourse liabilities and allocated based on the allocation of partnership profits.

HLB Gross Collins, P.C. is committed to providing clients with the best planning advice for maximum tax savings. Contact your HLB Gross Collins, P.C. tax specialist to discuss your specific situation and avoid missing out on potentially significant tax savings.

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