Using the IRC 754 Election by Denver Tax Attorney

In previous articles the issue surrounding a variance in inside and outside basis has been discussed and examples provided.  Now the question arises, can the issue be fixed?  The article below has been prepared by a Denver tax attorney at The McGuire Law Firm to further this discussion and to discuss the 754 election.

In our previous example, Woody purchased his 25% interest from Terry and even though Woody receives  step up in basis to the purchase price, he will step into Terry’s shoes regarding the capital account and his share of the inside basis.  Thus, the variance & disconnect between inside an outside basis has been created.

The variance may be prevented if the partnership makes an election under IRC Section 754, which allows a partnership to adjust the inside basis of partnership property when there is the sale of a partnership interest under IRC 743 or there is a distribution of partnership property under IRC 734.

In this article, we will discuss the scenario whereby a partnership interest is sold, which will match the fact pattern we have been following whereby Terry sold his interest to Woody.

So how can IRC Section 754 help?  Under Section 743, the inside basis of partnership property is adjusted as the result of a sale of a partnership interest if a Section 754 election is made.  The partnership can increase the adjusted inside basis of its property by the excess of the purchasing partner’s outside basis in the partnership interest over such partner’s share of the partnership’s inside basis of partnership assets.

Based off of our example, when Woody purchases the interest for $350,000, his outside basis will be $350,000 and inside basis is $250,000.  If a Section 754 election is made or in effect the partnership can increase the basis of the asset by the excess of Woody’s outside basis in the interest over Woody’s  share of the inside basis.  Thus, the partnership could increase the basis of the land by $100,000 ($350,000 – $250,000).  The $100,000 should match the amount that the selling partner (Terry) recognized on the sale.  It is important to remember that the basis increase is a tax concept only and specific to Woody, the purchasing partner.

Ok, so the election has been made, what happens when the partnership now sells the land?  There will be a book gain of $400,000 because the book basis was still $800,000 and the property sold for $1.2 M.  Thus for book purposes $100,000 would be allocated to all partners and increase their capital accounts to $350,000.  When computing the partnerships tax gain, the basis in the land for tax purposes is $900,000 rather than $800,000 because of the $100,000 increase.  Thus, $300,000 of tax gain is recognized which is allocated to the three partners apart from Woody (John, Jimmy and Jeff) and no gain is allocated to Woody.  This gain will increase outside basis of the other three partners.  Thus now the partner’s all have a capital account of $350,000 and basis of $350,000.

If you have tax questions related to your partnership or business, or even individual tax questions, you can speak with a Denver tax attorney or business attorney by contacting The McGuire Law Firm.

Example of an Inside and Outside Basis Problem Within a Parternship

In a previous article a tax attorney at The McGuire Law Firm drafted an article regarding inside and outside basis in a partnership to later further a discussion on IRC Section 754.  The article below will continue to discuss inside and outside basis and the problems or issues that can occur as we move forward with matters related to a 754 election.  The article below will assume the same facts from our July 15th article.

For now we will assume that after X has purchased A’s partnership interest JJJL LLC sells the land for $1.2 Million.  Under IRC 1001, the partnership will recognize gain in the amount of $400,000.  Because each partner has a 25% ownership interest in the partnership, each will be allocated 25% of the gain, which will be $100,000 to each partner.  This gain will increase each partner’s capital account and tax account by $100,000 and thus increase their capital account and tax basis under IRC Section 704.  Thus after the sale, the partnership has cash of $1.2 M and $200,000 in other assets totaling $1.4 M, and the partner’s all have a $350,000 basis in their capital accounts with a fair market value of $350,000.  However, Woody’s disparity between his capital account at $350,000 and outside basis of $450,000 will remain.

A problem has occurred!  When Terry sold his interest he recognized gain of $100,000 through the appreciation of the land and would have paid tax on such gain.  When the partnership sold the land, all $400,000 of appreciation in the land would trigger gain to be recognized and Woody will be taxed on $100,000 as well.  Why does this problem occur?  The problem is due to Woody’s interest being treated as an extension of Terry’s interest in the partnership.  In a vacuum, the same $100,000 is being taxed twice- once to Terry and once to Woody.  Is this not a violation of tax law and tax principles? Yes, and no, because the issue will eventually be worked out.

As an example, we will assume that a couple of years later the partnership sells the remaining assets with  a value of $200,000 and then the partnership will liquidate and distribute the $1.4 Million in cash.  Under IRC Section 704, when a partnership liquidates, it generally is required to make liquidating distributions in accordance with each partner’s positive capital account balance and thus each partner would receive $350,000.  Under IRC Section 731, when the partnership liquidates, each partner should recognize gain or loss for the difference between the amount received and their basis in the partnership.  However, the basis in the partnership is not the capital account or share of inside basis, but the outside basis of the partnership.  Thus, for John, Jimmy and Jeff these amounts are the same, but Woody has that difference in his outside and inside basis.  No gain or loss will be recognized by John, Jimmy or Jeff, but Woody will recognize a loss of $100,000 because his outside tax basis was $450,000.  Too bad for Woody that his capital gain and capital loss were recognized in separate tax years!  If Woody has not other capital gains to use the $100,000 capital loss offset, he may have to use $3,000 of the capital loss per year due to the capital loss limitation….. That could take Woody over 33 years to use such loss!

In a later article a Denver tax attorney from The McGuire Law Firm will discuss how the above issue may be able to be fixed and Section 754.  If you have tax questions or issues, speak with a Denver tax attorney by calling The McGuire Law Firm.  A free consultation is offered to all potential clients!

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Article on Partnership Inside & Outside Basis

Recently an issue came about regarding IRC Section 754 and it’s application to partnership matters.  The article below has been drafted by a Denver tax attorney at The McGuire Law Firm to initially discuss inside and outside basis, which will help to understand IRC Section 754.

When you hear the term “outside basis” in reference to a partnership, this refers to the basis the partnership has in the partnership assets, and how the basis of an asset is stated in partner’s capital account.  An example may be useful:  Assume John, Jimmy, Jeff and Terry form JJJT LLC and each will contribute $250,000 to JJJT LLC, which is taxed as a partnership.  After this capital infusion, the partnership will purchase land that has a value of $800,000 and other partnership assets with a value of $200,000.  Thus, when looking at the balance sheet for the partnership you would see land with a basis of $800,000 and other depreciable assets with a value of $200,000.  Further, the basis of each partner would be $250,000 with a total equity of $1,000,000.  Thus, each partner’s capital account is equal to the amount of money they contributed to the LLC, and the total of these capital accounts equals the total basis the LLC (partnership) has in the assets.  Thus, the inside basis of the partnership assets is $1 Million and each partner has a share of the inside basis of $250,000.  Thus, so far, everything is adding up and makes sense!

When you hear the term “outside basis” someone is referring to the basis a partners holds in their partnership interest.  Thus, using the example above, when the partner’s in JJJT LLC contributed $250,000 to the LLC, they will each take an initial basis in the partnership interest of $250,000, which is controlled by IRC Section 721 an states that a partner’s initial tax basis will be equal to the amount of cash and the adjusted tax basis of any property the partner contributes to the partnership.

So when and how does a problem come about?  From our example above, each partner has an outside basis equal to their share of the basis of the partnership assets, which is the inside basis of $250,000, but what happens when this changes?

Based upon the above example, we will assume that value of the land increases by 50% to $120,000 and thus the balance sheet would show that the land has a basis of $800,000 but a fair market value of $120,000 and the other assets have a basis of $200,000 and a fair market value of $200,000 and a total fair market value of $140,000.  Each partner would have a basis of $250,000 in their partnership interest and the each interest would hold a fair market value of $350,000.

Now to shake up the pot, Terry decides the value of the land has topped out and thus wants to sell his partnership interest.  Thus, Terry wishes to sell his partnership interest to Woody.  Terry’s value in his partnership interest is $350,000 and thus Woody will have to pay $350,000 for Terry’s interest.  When Terry sells his partnership interest gain will be recognized under IRC 741 of $100,000.  When Woody acquires the interest for $350,000 his initial basis is not controlled by IRC 721, but IRC 1012, which would hold that when a partner acquires the interest through a purchase, the initial basis would generally be the cost and thus $350,000 based upon the above facts.

What we now have is a difference between inside and outside basis.  Woody will have an outside basis in his partnership interest of $350,000, but nothing has changed regarding the inside basis.  Woody’s share of the inside basis would be $250,000 as Woody steps into Terry’s “smelly” shoes so to speak.  Thus, Woody’s capital account is different than his tax basis.  Woody would have a tax basis of $350,000 but a capital account of $250,000.  This difference can create problems that will be discussed in another article by a tax attorney.

Contact The McGuire Law Firm to discuss your tax questions with a Denver tax attorney.  Tax law can be confusing, but have a big impact on your business and business decisions.  You can discuss your issues and questions with a tax attorney and business attorney by contacting our firm.  Free consultation- 720-833-7705.

U.S. Tax Court Had Jurisdiction Regarding Outside Basis in a Partner Level Proceeding

As you may or may not know, a partnership is a pass through entity whereby items of income, gain, loss, deduction or credit are passed through to the individual partners and reported on their 1040 individual income tax returns.  The article below has been drafted by a Denver tax attorney at The McGuire Law firm to discuss a recent Tax Court decision that displays not only the Court’s jurisdiction, but how a determination at the partnership level can impact a partner’s individual income taxes.

The United State Tax Court has determined that is has jurisdiction over affected items deficiency proceedings incurred from prior proceedings at the partnership level.  The Court found that gain or loss through the disposition of a partnership interest was an affected item requiring determinations at the partner level where gain or loss would be affected by a partner level determination or determinations.

The Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA) partnership audit rules would generally hold that the tax treatment of any partnership item and the application of penalty or additions of tax via a deficiency notice, or additional amounts due to the adjustment of a partnership item would be determined at the partnership level- See IRC Section 6221.  Furthermore, under IRC Section 6224, a partner whose tax liability may be affected via the partnership litigation of partnership items can participate in the proceedings, and under IRC Section 6229(d) the IRS can assess additional tax to an individual partner within one year of the final conclusion or determination of the partnership items.

Prior to discussing the facts further, it may help to define and discuss some of the related terms.  A partnership item under IRC Section 6231 is an item (any item) that must be taken into account for the partnership’s tax year under the IRC to the extent the IRS regulations provide the item is most appropriately determined at the partnership level as opposed to the partner level.  Non-partnership items, which are also under IRC 6231 is an item that is not a partnership item.

The United States Tax Court has limited jurisdiction and can only exercise such jurisdiction allowed by statute.  If a taxpayer files a petition to the Tax Court, the Court does have jurisdiction to determine or re-determine the amount of the deficiency.  Generally, the deficiency procedure does not need to be followed to determine affected items coming from a TEFRA proceeding analyzing a partnership level matter, but an exception exists for affected items that require partner level determinations- see IRC Section 6230(a)(2)(A)(i).

A partnership can make an election to adjust the basis of partnership assets on the sale, transfer or distribution of a partnership interest by filing a statement of election with the partnership income tax return (generally Form 1065 US Partnership Income Tax Return) for the tax year of which the transfer or distribution of the interest occurs- See IRC Section 754.

The facts of the case at hand are as follows.  Mr. Greenwald was a limited partner in Regency Plaza Associates, and Regency petitioned the bankruptcy court for relief under Chapter 11 in 1996.  Regency terminated operations in 1997, and the IRS filed substitute returns for Regency in 1996 and 1997.  Regency was subject to TEFRA’s unified partnership audit and litigation procedure and in October 2007, the IRS issued a notice of final partnership administrative adjustment to tax years 1996 and 1997.  As a result, two of the partners apart from the tax partner filed petitions in tax court and Mr. Greenwald filed notices of election to participate in both cases and motions to have himself appointed the tax matters partner.  The Court granted these motions and the case was consolidated.

After the TEFRA proceeding, the IRS issued a notice of computational adjustment to Mr. Greenwald regarding the 1996 and 1997 Regency tax returns.  Additionally, the IRS issued a notice of deficiency to Mr. Greenwald for his 1997 individual income tax period adjusting his long term capital gains and other corresponding adjustments based upon the partnership adjustments.  Mr. Greenwald filed petitions to the notices of deficiency and argued to dismiss the cases for lack of jurisdiction because the outside basis issue was a partnership item and should been determined at the partnership level, and that the notices were invalid.  The Tax Court determined that the gain or loss through the transfer or distribution of a partnership interest was an affected item that required partner level determinations if the amount of gain or loss could be impacted by a partner level determination.

The Internal Revenue Service took the position that the Tax Court had jurisdiction because outside basis was an affected item that required partner level determinations, and the taxpayers argued that outside basis was a partnership item and therefore such issue need to have been raised during the prior partnership level proceedings.  The Court agreed with the neither the IRS nor the taxpayer, deciding that it had jurisdiction to “re-determine” the amount of a deficiency attributable to affected items because there were partner level determinations that were required.

The Tax Court decided that re-determining the amounts of deficiencies resulting from partnership level adjustment would make it necessary to review the partner’s specific facts.  For example, what if a partner incurred litigation or legal costs which could be added to their basis?  Such costs could be added to their basis, but would not necessarily be taken into account through an IRC Section 754 election, or another partnership level determination.  Moreover, determining that a partner did not incur such a cost or expense that could impact basis was a partner level determination as well.  Thus, the Tax Court had subject matter jurisdiction over the consolidated cases.

The tax implications of certain partnership decisions can be complicated.  If you have any questions regarding your partnership, you can speak with a Denver tax attorney or business attorney by calling The McGuire Law Firm.

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Tax Implications on Sale of Partnership Interest by Denver Tax Attorney

So you have worked hard with your partners and built a strong and respectful business.  Now you wish to sell your partnership interest.  Maybe you are looking to retire, or maybe you just want to try a new endeavor, but regardless you are going to sell your partnership interest.  As you begin the process, a thought crosses your mind, what are the tax implications when I sell my interest in this partnership?  Will I recognize gain?  Will I recognize a loss?  The article below drafted by a Denver tax attorney provides general information regarding the recognition of gain or loss when you do sell your partnership interest.

When a partner sells their partnership interest the partner will realize gain or loss.  To determine the gain or loss realized on this sale, you must determine the amount realized through the sale of the interest and the partner’s adjusted basis in their partnership interest.  The amount the partner will realize will include any cash and the fair market value of any property received.  Further, if the partnership has liabilities, the amount realized will include the partner’s share of the partnership liabilities.  If the partner remains liable for the debt, the amount realized will not include the partner’s share of the liability.  It is important to note that in regards to liability for partnership debt, if a partner indemnifies the selling partner for a partnership debt, the tax court has held that the amount realized will include the amount of which the partner has been indemnified.  Thus, once you know the amount realized, and the basis you can calculate gain or loss.  Below are some examples we will use to explain the pertinent matters.

Amount Realized: Jeffrey is a partner in the ABC Partnership of which has no outstanding liabilities.  Jeffrey sells his entire partnership interest to Doc for $25,000 cash and property that has a fair market value of $75,000.  Jeffrey’s amount realized is $100,000.

Amount Realized that Includes a Partnership Liability: Jeffrey is a partner in ABC Partnership and has a $15,000 basis in his interest.  Jeffrey’s partnership interest is 1/3 of the partnership.  When Jeffrey sells his 1/3 interest for $25,000 the partnership has a liability of $9,000.  Jeffrey’s amount realized would be $28,000 ($25,000 + $9,000 x 1/3).

Now that we have looked at examples in regards to amount realized, we will look at an example regarding gain realized.  From Example 1 above, assume that Jeffrey’s basis was $50,000.  Jeffrey’s realize gain would be $50,000 ($100,000 – $50,000).  Amount realized less the partner’s adjusted basis will provide the partner’s gain or loss through the sale of their partnership interest.

Now that you know the gain or loss, what is the next important question to ask?  What is the character of the gain?  Generally, the character of the gain would be determined by referencing the asset so.  Generally, a partnership interest is considered a capital gain and thus gain or loss through the sale of such interest would be considered a capital gain or capital loss.  However, under the collapsible partnership rules, it is possible to realize ordinary income.

I was once asked if the non-recognition provisions of a like kind exchange under IRC Section 1031 could apply to exchanges of partnership interest.  As far as I know, the like kind exchange provisions cannot apply to the exchange of partnership interests. However, Subchapter K of the Internal Revenue Code does allow the exchange of a limited partnership interest for a general partnership interest in the same partnership to qualify for non-recognition, but this is not due to a like kind exchange rule.

If you feel you or your business needs assistance with tax matters or business issues and would like to speak with a Denver tax attorney or business attorney, please contact The McGuire Law Firm.

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Netting a Partner’s Increase and Decrease of Partnership Liabilities

Under the 752 Treasury Regulations, if through a single transaction, a partner incurs both an increase and a decrease in the partner’s share of the partnership liabilities, only the net increase is treated as a contribution of money and only the net decrease is treated as a distribution of from the partnership.  Below is an example of netting the increase and/or decrease in a partner’s share of liability when property that is contributed to a partnership is subject to a liability.

Example: Jeff contributes property with an adjusted basis of $50,000 to a general partnership in exchange for a one quarter (1/4) interest in the general partnership.  At the time Jeff contributes the property, the partnership does not have liabilities outstanding and the property is subject to a recourse debt of $25,000.  The fair market value of the property is in excess of the $25,000 recourse debt.  After the contribution, Jeff remains personally liable to the creditor, Bank of Colorado and none of the other partners bear any of the economic risk for the $25,000 liability under state law or otherwise.  The partnership is treated as having assumed the $25,000 liability and as a result, Jeff’s individual liabilities have decreased by $25,000.  At the same time, Jeff’s share of the partnership liabilities has increased by $25,000.  Only the net increase or decrease in Jeff’s share of the partnership liabilities and Jeff’s individual liabilities are taken into account when applying Internal Revenue Code Section 752.  Thus, there is no net change for Jeff, and Jeff is not treated as contributing money to the partnership or receiving a distribution of property from the partnership.  Thus, Jeff’s basis in his partnership interest would be $50,000, which is the adjusted basis of the property Jeff contributed.

If you are partner in a partnership it is very important to have a general understanding of how contributions of property increase your partnership basis and how distributions of property decrease your partnership basis.  Moreover, it is very important to properly track your partnership basis from year to year and through certain transactions as they may occur in your business.  Your basis in the partnership can dictate the amount of gain (or loss) you may realize on the transfer or sale of your partnership interest or through the sale of the partnership.  Furthermore, your partnership basis allows you to pass through partnership losses.  Thus, your basis in the partnership must be tracked and should be considered and accounted for as you make certain business decisions.

You can speak with a tax attorney or business attorney at The McGuire Law Firm if you have questions related to your business.  A free consultation is offered to all potential clients, and The McGuire Law Firm has offices located in Denver, Colorado and Golden, Colorado.


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Deemed Cash Contribution to Partnership Via Assumption of Liability

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.

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Tax Attorney Discussion: Partnership’s Assumption of Liabilities

As a tax attorney and business attorney, John McGuire frequently works with a partner within a partnership who contributes property to a Denver Business Attorneypartnership such as an LLC and the partnership assumes the liability on the property.  When this occurs, a tax attorney will advise the contributing partner that their basis is decreased by the sum of the liabilities assumed.  Furthermore, a partner’s basis is increased by their share of the partnership liabilities.  The examples below should help illustrate this piece of tax law.

For example, assume Joe and Mike form a partnership. Joe contributes property with a basis of $100,000 that is subject to a debt of $60,000, and has a fair market value of $150,000.  Mike contributes property with a basis of $40,000 and fair market value of $60,000.  Further, assume Joe and Mike are equal partners, each holding a 50% ownership interest in the partnership.  Joe’s adjusted basis would be $70,000, calculated: $100,000 basis plus $30,000 share of the $60,000 liability assumed by the partnership less the $60,000 liability ($100,000 + $30,000 – $60,000= $70,000).  Mike’s adjusted basis would be $70,000 as well, calculated: $40,000 basis plus $30,000 share of the $60,000 ($40,000 + $30,000).

Under the regulations for IRC Section 722, the tax basis of a partnership cannot be negative.  Therefore, if the liabilities assumed by the partnership exceed the contributing partner’s basis in the property the excess is treated as a distribution of cash.  For example, if Joe had an adjusted basis of $100,000 in property he is contributing to a partnership, with a $150,000 liability that is assumed by the partnership, the $50,000 of liability in excess of Joe’s basis would be treated as a cash contribution from the partnership to Joe.

Some partner’s have attempted to contribute a promissory note to the partnership to prevent the debt assumed by the partnership exceeding their adjusted basis in the contributed property.  The contribution of a promissory note to the partnership does not increase the contributing partner’s basis under IRC Section 722 because the basis in the promissory note would be $0.

The partnership will have a carryover basis and thus the basis in the hands of the contributing partner will be the partnership’s basis in the property contributed.  Further, the partnership’s holding period for the property contributed will include the contributing partner’s holding period if the property contributed is a capital asset or is IRC Section 1231 property.

Individuals forming a partnership or contributing property to a partnership should consult with their business attorney and/or their tax attorney to discuss the tax implications to their partnership interest and to the partnership.

Contact The McGuire Law Firm to schedule a free consultation with a tax attorney or business attorney in Denver.

Recourse and Nonrecourse Debt in an LLC by Tax Attorney

Recourse and Nonrecourse Debt in an LLC Denver Business Attorneys

As a tax attorney and business attorney, John McGuire of The McGuire Law Firm works with partnerships regarding the impact of partnership debt and the impact of recourse and nonrecourse debt.  The article below outlines law to consider regarding partnership debt.  If you have a question regarding partnership debt, contact The McGuire Law Firm to speak to a Denver tax attorney or business attorney through a free consultation.

Whether or not debt within a Limited Liability Company (LLC) is recourse or nonrecourse can have a profound impact on certain partners within an LLC.  Whether debt is recourse or nonrecourse in the eyes of the Internal Revenue Service is determined by partners actually bearing the risk of economic loss.  Under subchapter K of the Internal Revenue Code, all LLC debt, regardless of how the debt is labeled, is treated as nonrecourse debt under an economic risk analysis.

An LLC debt is considered not recourse debt under the following circumstances:

–          A member of the LLC or person related to the applicable member guarantees or makes a loan to the LLC;

–          Separate state law obligations to a member(s) exists (a member is liable for the recourse debts of a previous partnership);

–          The debts falls under the interest guarantee rule of Regulations Section 1.752-2(e) or the property pledge rules of Regulation Section 1.752-2(h); or,

–          The anti-abuse rule applies under Regulation Section 1.752-2(j).

When analyzing a partner’s share of partnership liability, the 752 Regulations first consider whether the debt is recourse debt or nonrecourse debt.  Under Regulation Section 1752-2 a debt is recourse to a member of an LLC if that member (partner) bears the risk of economic loss for the applicable liability.  The debt is nonrecourse if no member or partner bears the risk of economic loss.  If partner has an obligation to make a contribution to the partnership or to pay a creditor upon liquidation of the partnership, the partner would bear the risk of economic loss to the extent of the obligation.  For example, if a partner guaranteed the partnership’s nonrecourse liability, such partner would have an obligation upon the constructive liquidation of the partnership and bear the economic risk.  Therefore, such liability would be a recourse debt to the partner.  Moreover, if the partner acted as lender, and loaned money to the partnership as a nonrecourse liability to the partnership, such partner would be considered to bear the economic risk of the loan.

Under the 752 Regulations, the owner of a disregarded entity is treated as bearing the economic risk for obligations of the disregarded entity, to the extent of the disregarded entity’s net value on the date the partnership determines  the partner’s share of the liability.

A tax attorney and business attorney at The McGuire Law Firm can assist you regarding partnership debt, basis, formation, structure, operating agreements, taxation issues, allocable shares to partners, transfer or sale of partnership interests and other partnership issues.

Contact The McGuire Law Firm and schedule a free consultation with a tax attorney and business attorney in Denver or Golden.