Taking on debt with nonrecourse liability has several advantages. In general, when acquiring property subject to debt, the acquiring party stands to benefit more from nonrecourse debt rather than recourse. With that in mind, you may be asking yourself what exactly the difference is between the two. This article has been prepared by a Denver business attorney to discuss some of the issues related to recourse debt versus nonrecourse 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 pursuant 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 personal assets are at risk. On the other hand, with nonrecourse debt, the creditor may recapture only the collateral if the debtor defaults on the debt. For example, if you had a nonrecourse debt for the purchase of business assets and defaulted on the purchase note whereby the assets were purchased, the creditor could only look to the business assets purchased to recoup their money and satisfy the promissory note. Had the debt been recourse debt, the creditor could also collect from you individually based upon your personal assets. In addition to creditor issues, whether or not debt is recourse debt or nonrecourse debt can impact your basis in the asset(s) acquired with the debt.
Two major concerns arise in respect to the acquisition of property subject to nonrecourse debt. First, you must consider your basis in the property and whether the nonrecourse debt is included. Second, you must consider whether the nonrecourse debt is considered 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.
Basis is a way of keeping track of your cost in property for tax purposes. When it comes to nonrecourse debt, there is a concern that taxpayers 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 will need to include the amount of the nonrecourse debt in the basis of 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, nonrecourse 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 nonrecourse debt is included in the amount realized upon disposition of the property. Assuming that the nonrecourse liability was included in the basis of the property originally, if the taxpayer later chooses to sell the property, he or she will need to include 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, and this holds the taxpayer responsible for the benefits and drawbacks on nonrecourse debt.
It is important to highlight that not all nonrecourse debt is included in basis so you must consider the value of the property in relation to the debt. There is substantial case law outlining various situations where nonrecourse basis has not been included in basis. 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.