Under Internal Revenue Code section 752(a) an increase in a partner’s share of partnership liabilities, or an increase in a partner’s individual liabilities by reason of the assumption by such partner of a partnership liability or liabilities, shall be considered as a contribution of money by such partner to the partnership. Because the assumption of a liability is treated as a contribution of money by the partner, the partner’s basis in the partnership will increase under Internal Revenue Code section 722 by the amount of the deemed cash contribution.
IRC 752(a) would appear easy enough right? Not exactly! The issue of what constitutes a liability and thus can increase a partner’s basis can become quite complex and one should refer to the section 752 Treasury Regulations, of which certain sections are discussed below.
Section 1.752-2(a) of the Treasury Regulations states generally that, “A partner’s share of a recourse partnership liability equals the portion of that liability, if any, for which the partner or related person bears the economic risk of loss.” Thus, the regulations are focusing on economic risk, and more or less, what a partner is exposing themselves too when assuming the liability. To view a partner’s economic risk of loss, the regulations assume a deemed liquidation of the partnership whereby the partnership liquidates, all assets are sold for nothing and the partner who has assumed the debt is more or less left to deal with the creditor or creditors- Thus what is the real risk to the partner if the partnership were liquidated and gone, and unable to pay the liability or liabilities assumed by the partner? Specifically, the regulations state:
“Except as otherwise provided in this section, a partner bears the economic risk of loss for a partnership liability to the extent that, if the partnership constructively liquidated, the partner or related person would be obligated to make a payment to any person (or a contribution to the partnership) because that liability becomes due and payable and the partner or related person would not be entitled to reimbursement from another partner or person that is a related person to another partner. Upon a constructive liquidation, all of the following events are deemed to occur simultaneously:
All of the partnership’s liabilities become payable in full;
With the exception of property contributed to secure a partnership liability (see section 1.752-2 (h)(2)), all of the partnership’s assets, including cash, have a value of zero;
The 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);
All items of income, gain, loss, or deduction are allocated among the partners; and
The partnership liquidates.”
Now that we know how the regulations view economic risk, what constitutes an assumption of a liability? Under Treasury Regulations section 1.752-1(d), a partner is considered to have assumed a liability to the extent that the partner is personally obligated to pay the liability. Furthermore, section 1.752-1(d)(2) provides a requirement that the person to whom the liability is owed, has knowledge of the assumption and can directly enforce the partner’s obligation for the liability, and no other partner or person that is a related person to another partner would bear the economic risk of loss for the liability immediately after the assumption.
Thus, a partner can increase their partnership basis via a deemed cash contribution when they assume a partnership liability, and bear the risk of economic loss from such assumption. To discuss partnership formation and related issues, you can contact The McGuire Law Firm. The above article is solely to provide general information and should not be construed as tax or legal advice. The McGuire Law Firm does not provide legal advice via the internet.