RECOURSEIs the partnership a General Partnership?

In a General Partnership, all partners have personal liability for the recourse debts of the entity. Debt should be allocated according to the hypothetical liquidation approach discussed on page 2. (Treas. Reg. §1.752-2(a)) (See Example 1 on page 3)

Have any of the limited partners either 1) personally guaranteed the recourse debt and waived their right for reimbursement or 2) does the partnership agreement provide that the limited partner is required to make an additional capital contribution to the partnership?

Is the partnership a Limited Partnership?

Is the partnership an LLC?

An LLC member can be allocated recourse debt of the partnership to the extent of their obligations under 1 and 2 above. The remaining liability must be treated as nonrecourse debt and allocated accordingly.(Treas. Reg. §1.752-2(b)) (See Example 4 on page 3)

Did any of the LLC members agree per the partnership agreement to either 1) guarantee the debt or 2) restore a deficit balance in their capital account upon liquidation?

Except for the limited circumstances discussed above, the general rule is that LLC debt (state law recourse or nonrecourse) cannot be allocated among members as recourse debt because none of the members has any economic risk for the debt. For state law recourse debt, a creditor may sure the LLC but may not enforce the debt against the members. Thus, unless a member takes on the additional risk, all LLC debt is treated as nonrecourse for tax purposes.

A limited partner can be allocated recourse debt of the partnership to the extent of their obligations under 1 and 2 above. The remaining liability must be allocated amongst the general partners pursuant to the hypothetical liquidation method. (Treas. Reg. §1.752-2(b)) (See Example 2 on page 3)

All recourse liabilities should be allocated among ONLY the general partners according to their risk of loss under the hypothetical liquidation approach. (See Example 3 on page 3)

YES

YES

YES

YES

NO

NO

NO

NO

Is the liability recourse, nonrecourse, or qualified nonrecourse? (see definition on Page 2)

For all liabilities, an amount loaned by a partner to the partnership, or an amount guaranteed by the partner, should be allocated to that particular partner as a recourse liability.

ALLOCATING PARTNERSHIP LIABILITIES ON SCHEDULE K-1

Does the partnership own depreciable assets secured by the nonrecourse liability? Allocate same way as nonrecourse

liabilities.

Have depreciation deductions reduced the tax basis of the asset secured by the liability below the principal balance of the liability?

Did either partner contribute an appreciated asset to the partnership that is secured by a nonrecourse liability?

Each partner must be allocated an amount of the liability equal to their share of the minimum gain (debt principal balance in excess of tax basis of the asset).(Treas. Reg. §1.752-3(a)(1)) (See page 2 for definition)(See Example 5 on page 3)

The contributing partner must be allocated nonrecourse liabilities to the extent of any difference between the principal balance of the nonrecourse liability and the adjusted tax basis of the property at the time of the contribution under §704(c). Any remaining liability is to be allocated according to profit ratio. (Treas. Reg. §1.752-3(a)(2)) (See Example 6 on page 3)

Allocate the nonrecourse liability based on profit ratios.(Treas. Reg. §1.752-3(a)(3))

NONRECOURSE QUALIFIED NONRECOURSE

YES

YES

YES

NO

NO

NO

Partnership Liabilities and Basis, In General

How do we allocate partnership liabilities on Schedule K-1?

Under IRC Section 752, a partner’s share of partnership liabilities is treated as a cash contribution, increasing the partner’s basis in the partnership interest and allowing the partner to deduct losses to the extent of that basis under §704.

IMPORTANT NOTE: ALL partnership liabilities allocated to a particular partner give that partner additional basis for §704 purposes for deducting losses, not just recourse liabilities.

IMPORTANT NOTE 2: While all partnership liabilities allocated to a particular partner will give that partner additional basis under §704, not all liabilities allocated to a partner will give the partner at-risk basis for purposes of deducting losses under §465. In general, only recourse liabilities and qualified nonrecourse liabilities generate at-risk basis.

STEP 1: DETERMINE IF A PARTNERSHIP LIABILITY IS RECOURSE, NONRECOURSE, OR QUALIFIED NONRECOURSE.

Recourse: A liability is classified as recourse under the current partnership regulations to the extent that any partner bears the economic risk of loss for the liability. A partner bears the economic risk of loss for a partnership liability to the extent that if the partnership constructively liquidated and the assets were insufficient to pay the liabilities, the partner would be obligated to make a payment to the creditor or a contribution to the partnership with no right of reimbursement from another party.

Nonrecourse: A liability is classified as nonrecourse under the current partnership regulations as any liability for which no partner bears the economic risk of loss for that liability. The most common type of nonrecourse liability is a loan for which property (typically real estate) is pledged as security for repayment and for which the lender’s only remedy in the event of a default is to foreclose on the property. (Treas. Reg. §1.752-1(a)(2))

Qualified Nonrecourse Liabilities: Qualified nonrecourse financing is debt that is borrowed in connection with the activity of holding real property. As discussed above, qualified nonrecourse liabilities are allocated exactly the same as nonrecourse liabilities. The only difference is qualified nonrecourse liabilities generate at-risk basis, while nonrecourse liabilities do not. (IRC §465)

STEP 2: ALLOCATING RECOURSE LIABILITIES UNDER THE §752 REGULATION.How do we determine the extent to which a partner bears an economic risk of loss with respect to a partnership recourse liability?

You must go through a hypothetical liquidation in which:

1. All of the partnerships liabilities become payable in full2. All of the assets become worthless. 3. All of the property is disposed of for no consideration

(except relief from nonrecourse liabilities)4. All items of income, gain, loss are allocated among the

partners (Treas. Reg. §1.752-2(b)(1))

Ex: A and B form a GP an d contribute $20,000 cash each. They use the $40K and borrow $60K to buy a building for $100K. Each partner is jointly and severally liable for the $60K loan. The

partnership agreement says A and B share income equally, but A gets 80% of all losses. Upon a constructive liquidation:

1. The $60K is due in full2. The building is deemed worthless. 3. There is a hypothetical sale of the building for $0.4. The partnership recognizes a $100,000 loss on the sale of

the building. 5. A is allocated $80K of loss, B’s capital account goes to

$20K. A’s capital account goes to $60K B to $0. As a general partner, A is required under state law to replenish his negative capital account.

6. As a result, A is allocated the full $60K of the recourse liability.

STEP 3: ALLOCATION OF NONRECOURSE LIABILITIES.1. Allocate nonrecourse liability in proportion to each

partners share of minimum gain. This will only apply if the partnership owns depreciable assets securing the nonrecourse liability. Minimum gain is the amount by which the principal balance of a nonrecourse liability exceeds the tax basis of the asset securing it.

2. Allocate nonrecourse liabilities to any partner that contributed appreciated property secured by a nonrecourse liability that had a FMV in excess of its tax basis at the time of contribution. The amount of nonrecourse liability allocated to the partner is the amount of the liability in excess of the tax basis at the time of contribution.

3. Allocate remaining nonrecourse liabilities based on partners’ profit sharing ratios.

STEP 4: ALLOCATION OF QUALIFIED NONRECOURSE LIABILITIES.For purposes of allocating basis to partners from partnership debt under the Section 752 rules, there is no distinction between garden-variety nonrecourse debt and nonrecourse debt that meets the definition of qualified nonrecourse financing. The distinction is only relevant for purposes of applying the Section 465 at-risk. (IRC §465(b)(6))

EXAMPLES

IF YOU HAVE ANY QUESTIONS PLEASE CONTACT TONY NITTI, 970.925.7382.

Allocation of Nonrecourse Debt in LLC; Partnership has §704 Contribution A and B form the AB, LLC on a 60/40 basis. A contributes

law with a FMV of $100,000 and a tax basis of $25,000, secured by a nonrecourse $40,000 mortgage. B contributes $40,000 cash. If the property were disposed of for nothing but the relief of the nonrecourse liability, AB would recognize $15,000 of gain ($40,000 debt relief - $25,000 basis). This gain would all be allocated to A under §704(c). As a result, A should be allocated the first $15,000 of the nonrecourse liability, with the remaining $25,000 being split 60/40 between A and B.

6Allocation of Nonrecourse Debt in GP; Partnership has Minimum Gain A and B for Partnership AB, a general partnership. A

contributes $20 and B contributes $180. The partnership borrows $800 on a nonrecourse basis and purchases a building for $1,000. The loan is secured by the property. A, as the general partner, is obligated to restore a negative capital account. B, as the limited partner, is not. A is allocated 90% of all depreciation deductions but income is split 50/50. Depreciation is $90 per year. In year 3, when the building has a tax basis of $730, the partnership has minimum gain, as the debt balance ($800) exceeds the tax basis of the assets securing it ($730). This $70 of minimum gain would be allocated $63 to A and $7 to B, as that is how they were allocated the depreciation deductions. Accordingly, A should be allocated the first $63 of debt and B the first $7. The remaining $730 of debt should be split 50/50 according to the profit ratios.

5Allocation of Recourse Debt in LLC; one Member Guarantees the Debt G and H are the sole members of GH, LLC. They share

profits and losses 60/40. G has personally guaranteed all LLC liabilities. G contributed $60 to the LLC, and H $40. The LLC borrowed $100 and purchased a building. Upon a hypothetical liquidation, Partnership ABC would recognize a $200 loss, and the loss would be allocated $120 to A and $80 to B. A’s capital account becomes ($60) and B’s becomes ($40). However, because G has guaranteed the debt personally, he bears the full risk of loss and is allocated the full $100 of debt.

Alternatively, G does not guarantee the debt, but instead agrees to restore any deficit capital account upon liquidation. In the facts above, A would be allocated only $60 of the debt as recourse debt, and the remaining $40 would be treated as nonrecourse debt to be allocated under the applicable rules.

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Allocation of Recourse Debt in Limited Partnership; Limited Partner Does not Have DRO Limited Partnership ABC has a general partner A, with

a capital account of $75 and a limited partner B, with a capital account of $25. B is not obligated to restore any negative capital account upon liquidation of the partnership. Partnership ABC borrowed $100 on a recourse basis and allocates losses 75% to A and 25% to B. Upon a hypothetical liquidation, Partnership ABC would recognize a $200 loss, and the loss would be allocated $150 to A and $50 to B. A’s capital account becomes ($75) and B’s becomes ($25). Because B is not required to restore any deficit in his capital account, he does not bear the risk of loss for the $25 negative capital account, and the entire $100 of debt is allocated to A.

3Allocation of Recourse Debt in Limited Partnership; Limited Partner had DRO Limited Partnership ABC has a general partner A, with

a capital account of $75 and a limited partner B, with a capital account of $25. B has specifically agreed in the partnership agreement to restore any negative capital account upon liquidation of the partnership. Partnership ABC borrowed $100 on a recourse basis and allocates losses 75% to A and 25% to B. Upon a hypothetical liquidation, Partnership ABC would recognize a $200 loss, and the loss would be allocated $150 to A and $50 to B. A’s capital account becomes ($75) and B’s becomes ($25). Because B is required to restore any deficit in his capital account, he bears the risk of loss for the $25 negative capital account, and is allocated $25 of the liability. A is allocated the remaining $75.

2Allocation of Recourse Debt in General Partnership In general partnership AB, Partners A and B share profits 50/50 but losses 80/20. A contributes $20K,

B contributes $20K, and the partnership borrows $60K on a recourse basis. The partnership buys a building for $100,000. Upon a hypothetical liquidation, the 1) $60K becomes due, 2) the building becomes worthless, 3) the partnership sells the building for $0, recognizing a $100,000 loss, and 4) that loss is allocated $80K to A and 20K to B pursuant to the partnership agreement. After the loss, As capital account is ($60) 20K-80K while B’s capital account is $0 (20K-20K). Since A bears the economic risk of loss to the extent of the $60K, A should be allocated all $60K of the liability.

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