Advantages of Taking on Debt with Non-Recourse Liability
Taking on debt with non-recourse liability has several advantages. Generally, when acquiring property subject to debt, the acquiring party benefits more from non-recourse debt rather than recourse. With that in mind, you may be asking yourself the difference between the two. A Denver business attorney has prepared this article to discuss issues related to recourse and non-recourse debt.
Recourse debt essentially allows the creditor to come after you and your assets personally if you default on the debt obligation, such as failing to repay the debt according to a promissory note. In other words, the creditor may not only take the collateral securing the debt but can also hold you personally liable for the difference between the debt balance and the fair market value of the collateral. Thus, your assets are at risk. On the other hand, with non-recourse debt, the creditor may recapture only the collateral if the debtor defaults on the debt. For example, suppose you had a non-recourse debt for purchasing business assets and defaulted on the purchase note whereby the assets were purchased. In that case, the creditor could only look to the business assets purchased to recoup their money and satisfy the promissory note. Had the debt been recourse, the creditor could also collect from you individually based upon your assets. In addition to creditor issues, whether or not the debt is recourse or non-recourse debt can impact your basis in the asset(s) acquired with the debt.
Concerns when Obtaining Property Subject to Non-Recourse Debt
Two significant concerns arise regarding acquiring property subject to non-recourse debt. First, you must consider your basis in the property and whether the non-recourse debt is included. Second, you must consider whether the non-recourse debt is regarded as part of your amount realized upon disposition of the property. The cornerstone case for these two issues comes from a famous case, Crane, which was decided in 1947.
The basis is a way of tracking your property cost for tax purposes. Regarding non-recourse debt, taxpayers are concerned that they will take advantage of the lack of liability for the funds and yet still benefit from a higher basis and increased depreciation allowances. The court in Crane found that a taxpayer must include the amount of the non-recourse debt based on the property. The taxpayer will generally prefer a higher basis in the property for depreciation purposes because the tax benefit is better today than in the future.
However, non-recourse debt will not always be respected by the IRS in terms of basis. Disallowance of basis is determined by looking at the fair market value of the property and the underlying contractual arrangement surrounding the acquisition of the property.
Another concern is whether the non-recourse debt is included in the amount realized upon disposition of the property. Assuming that the non-recourse liability was included in the basis of the property initially, if the taxpayer later chooses to sell the property, they will need to have the amount of the debt in the amount realized. The reasoning is that the taxpayer is disposing of a liability for which he was able to retain a tax benefit, which holds the taxpayer responsible for the benefits and drawbacks of non-recourse debt.
It is essential to highlight that not all non-recourse debt is included in the basis, so you must consider the property’s value to the deficit. Substantial case law outlines various situations where a non-recourse basis has not been included. For further information, you will need to analyze the tax consequences under your particular facts and circumstances with your tax attorney or business attorney.
You can speak with a Denver business attorney at The McGuire Law Firm- call 720-833-7705.