Pass-Through Liabilities and Federal Tax Treatment: Resolving Complex Issues

Transcription

1 Presenting a live 110-minute teleconference with interactive Q&A Pass-Through Liabilities and Federal Tax Treatment: Resolving Complex Issues Reporting Liabilities for General or Limited Partnerships and LLCs Given Tax Code Inconsistencies WEDNESDAY, AUGUST 28, pm Eastern 12pm Central 11am Mountain 10am Pacific Today s faculty features: Carolyn Turnbull, CPA, MST, Consultant, Orlando, Fla. Belan Wagner, Managing Partner, Wagner Kirkman Blaine Klomparens & Youmans, Mather, Calif. For this program, attendees must listen to the audio over the telephone. Please refer to the instructions ed to the registrant for the dial-in information. Attendees can still view the presentation slides online. If you have any questions, please contact Customer Service at ext. 10.

2 Sound Quality Call in on the telephone by dialing and enter your PIN when prompted. If you have any difficulties during the call, press *0 for assistance. You may also send us a chat or sound@straffordpub.com immediately so we can address the problem. Viewing Quality To maximize your screen, press the F11 key on your keyboard. To exit full screen, press the F11 key again.

3 FOR LIVE EVENT ONLY Attendees must stay on the line throughout the program, including the Q & A session, in order to qualify for full continuing education credits. Strafford is required to monitor attendance. Record verification codes presented throughout the seminar. If you have not printed out the Official Record of Attendance, please print it now (see Handouts tab in Conference Materials box on left-hand side of your computer screen). To earn Continuing Education credits, you must write down the verification codes in the corresponding spaces found on the Official Record of Attendance form. Please refer to the instructions ed to the registrant for additional information. If you have any questions, please contact Customer Service at ext. 10.

4 If you have not printed the conference materials for this program, please complete the following steps: Click on the + sign next to Conference Materials in the middle of the lefthand column on your screen. Click on the tab labeled Handouts that appears, and there you will see a PDF of the slides and the Official Record of Attendance for today's program. Double-click on the PDF and a separate page will open. Print the slides by clicking on the printer icon.

5 Pass-Through Liabilities and Federal Tax Treatment: Resolving Complex Issues Seminar Aug. 28, 2013 Belan Wagner, Wagner Kirkman Blaine Komparens & Youmans Carolyn Turnbull, CPA, MST, CGMA Independent Tax Consultant

6 Today s Program Liability Characterization Under IRC Sect [Belan Wagner] Slide 8 Slide 10 Treatment Of Partnership Liabilities Under IRC Sect. 752 [Carolyn Turnbull, Belan Wagner] Slide 11 Slide 32 Examples Of Taxpayer Situations [Belan Wagner, Carolyn Turnbull] Slide 33 Slide 70 At-Risk Rules Under IRC Sect. 465 [Carolyn Turnbull] Slide 71 Slide 79 Concluding Remarks [Carolyn Turnbull, Belan Wagner] Slide 80

7 Notice ANY TAX ADVICE IN THIS COMMUNICATION IS NOT INTENDED OR WRITTEN BY THE SPEAKERS FIRMS TO BE USED, AND CANNOT BE USED, BY A CLIENT OR ANY OTHER PERSON OR ENTITY FOR THE PURPOSE OF (i) AVOIDING PENALTIES THAT MAY BE IMPOSED ON ANY TAXPAYER OR (ii) PROMOTING, MARKETING OR RECOMMENDING TO ANOTHER PARTY ANY MATTERS ADDRESSED HEREIN. You (and your employees, representatives, or agents) may disclose to any and all persons, without limitation, the tax treatment or tax structure, or both, of any transaction described in the associated materials we provide to you, including, but not limited to, any tax opinions, memoranda, or other tax analyses contained in those materials. The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser.

8 Belan Wagner, Wagner Kirkman Blaine Komparens & Youmans LIABILITY CHARACTERIZATION UNDER IRC SECT. 1001

9 I. Background Liability Characterization Under IRC 1001 A. Determination of whether a liability is recourse or nonrecourse is generally made according to state law. B. Characterization of partnership liability is made at the partnership level (e.g., see Gershkowitz, TC, 1987) 9 II. Nonrecourse liability A. Defined in Black s Law Dictionary as a secured loan that allows the lender to attach only the collateral, not the borrower s personal assets, if the loan is not repaid. B. A transfer of property that secures a nonrecourse loan to the creditor in satisfaction of the loan results in gain or loss from a sale or exchange to the debtor under 1001, equal to the difference between the debtor s adjusted basis in the property and the adjusted issue price of the debt.

10 Liability Characterization Under IRC 1001 (Cont.) I. Recourse liability A. Defined in Black s Law Dictionary as a loan that allows the lender, if the borrower defaults, not only to attach the collateral but also to seek judgment against the borrower s (or guarantor s) personal assets. B. A transfer of property to the creditor in satisfaction of a recourse loan is bifurcated into: 1. Sale or exchange income from the property under 1001, to the extent of the difference between the property s FMV and the taxpayer s adjusted basis in the property at the time of the transfer; and 2. COD income, to the extent the adjusted issue price of the debt exceeds the FMV of the property. 10

11 Carolyn Turnbull, CPA, MST, CGMA, Independent Tax Consultant Belan Wagner, Wagner Kirkman Blaine Komparens & Youmans TREATMENT OF PARTNERSHIP LIABILITIES UNDER IRC SECT. 752

12 Background I. A partner s basis in a partnership interest includes the partner s share of the partnership liabilities. II. 752(a) Assumption by the partner of partnership debt, or increase in partner s share of partnership debt treated as contribution of money to partnership III. 752(b) Assumption by the partnership of partner debt, or decrease in partner s share of partnership debt treated as distribution of money by partnership to partner 12

13 Background (Cont.) I. 752(c) A liability to which property is subject is, to the extent of the FMV of the property, considered a liability of the owner of the property II. 752(d) In the case of a sale or exchange of a partnership interest, liabilities are treated in the same manner as liabilities in connection with the sale or exchange of property not associated with partnerships. 13

14 Allocation Of Partnership Liabilities Under 752 Understand how liabilities affect the calculation of a partner/member s basis and at-risk amount in her partnership interest Determine the effect of liabilities on the basis in the investor s hands of property received as a distribution from a partnership Distinguish between recourse and nonrecourse liabilities of a partnership Measure a partner s or member s share of recourse liabilities of a partnership 14

15 Allocation Of Partnership Liabilities Under 752 (Cont.) Measure a partner s share of nonrecourse liabilities of a partnership Analyze the impact of a partner guarantee of a recourse or nonrecourse liability of the entity Understand the provisions governing allocation of nonrecourse deductions of a partnership 15

16 Contribution Of Encumbered Property I. Net relief of liabilities treated as a distribution of cash II. Will result in gain to contributing partner at partnership formation, if net relief of liabilities is greater than basis of property contributed 16

17 Distribution Of Encumbered Property I. Net assumption of debt is treated as a contribution of cash to partnership. II. Net relief of debt is treated as a distribution of cash. 17

18 Allocation Of Partnership Liabilities Under 752 I. Recourse liabilities allocated as if partnership lost everything and then liquidated (i.e., partnership constructively liquidated) what partners would have to repay creditors or other partners II. Same rules do not apply to nonrecourse liabilities, because no one would have to repay those liabilities. 18

19 Slide Intentionally Left Blank

20 Recourse Liabilities I. If any partner or related person bears risk of loss for debt, it is a recourse debt. 20 A. Determined without regard for how the liability is characterized under state law II. Partner s share of partnership recourse debt equals the amount for which the partner or related person bears the economic risk of loss. III. Nonrecourse loans recharacterized if: A. Loan or interest thereon is guaranteed by one or more partners B. Collateralized by property owned by a partner C. Loan obtained from a partner

21 Constructive Liquidation I. Constructive liquidation all of the following events are deemed to occur simultaneously: A. All of the partnership liabilities become payable in full. B. With the exception of property contributed to secure a partnership liability, all of the partnership s assets, including cash, have a value of zero. C. 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). D. All items of income, gain, loss and deduction are allocated among the partners. E. The partnership liquidates. 21

22 Constructive Liquidation (Cont.) I. Partners who have deficit restoration provisions are presumed to contribute any deficit balance in their capital account to the partnership. II. Debt allocations based on book capital accounts (and deficits therein) III. If the partnership agreement provides for any special allocations, liability allocations will change every year. 22

23 Effect Of Partner Guarantees I. Guarantee of nonrecourse loan makes that loan recourse for purposes of 752. II. Loan guarantee is ignored, however, for purposes of allocating guaranteed debt, unless the guarantor has no further recourse against remaining partners. 23

24 Nonrecourse Liabilities I. Allocated among all partners, limited and general II. Allocations are generally based on profit-sharing ratios, because debts will be repaid, if at all, by reduced profit distributions. 24

25 Nonrecourse Liabilities (Cont.) I. Partners interests in profits considered in following order: A. Share of partnership book minimum gain B. Sect. 704(c) minimum gain C. Other partnership profits D. Partnerships may choose to allocate excess nonrecourse debt to contributing partner, to the extent of built-in gain allocable to such partner under 704(c). 25

26 Minimum Gain I. Minimum gain is equal to the excess of principal balance of nonrecourse debt over the 704(b) book value of property encumbered by nonrecourse debt, II. If book value exceeds tax basis, there will also be tax minimum gain. A. If 704(c) applies to this portion of minimum gain, allocation of underlying nonrecourse debt may be affected. 26

27 Example I. Partnership AB has property encumbered by nonrecourse debt that was previously contributed by Partner B. A. Book value of property is $250,000, tax basis is $200,000, and principal balance of nonrecourse mortgage is $315,000. B. Book minimum gain is $65,000. C. 704(c) minimum gain is $50,000. D. Total minimum gain is $115,000 II. Allocation of the $315,000 nonrecourse liability between partner A and B s bases is determined by taking the sum of each partner s interests in: A. Tier 1: The partner s share of partnership book minimum gain ($65,000); B. Tier 2: The partner s allocation of tax minimum gain under 704(c) ($50,000); and C. Tier 3: The partner s share based on ownership interests ($200,000). 27

28 Allocation Of Nonrecourse Deductions I. What constitutes a nonrecourse deduction? A. A nonrecourse deduction is defined as one that reduces the entity s net assets (on the 704(b) balance sheet) to a level below the outstanding principal of its nonrecourse liabilities B. To have nonrecourse deductions, there must be no remaining partner or member capital, or recourse debt, to absorb the partnership loss. 28

29 Nonrecourse Deductions I. Allocations will be recognized if: A. Partnership agreement calls for proper maintenance of capital accounts. B. Liquidation proceeds must be distributed based on capital balances. C. Partnership agreement requires either deficit restoration or minimum gain chargeback. D. Allocation must be reasonably consistent with allocations of some other significant partnership item(s) attributable to the encumbered property. E. All other material entity allocations and capital account adjustments must be recognized under the regulations. 29

30 Minimum Gain Chargeback I. Minimum gain is equal to the excess of nonrecourse debt over property basis. II. Each partner s share is the sum of the partner s previous nonrecourse deductions. III. This gain must first be allocated to partners with deficit capital balances, to the extent of such deficits. 30

31 Slide Intentionally Left Blank

32 Partner Nonrecourse Debt I. Partner nonrecourse debt is: A. Partnership nonrecourse debt for purposes of Reg , and, B. A partner or related person bears the economic risk of loss (e.g., because the partner or related person is the creditor or guarantor). II. Partner nonrecourse deductions and partner minimum gain are generally allocated to the partner who bears the economic risk of loss (or for which a related party bears the risk of loss) for the partner nonrecourse debt. A. Partner minimum gain chargeback is allocated to the partner who received the allocation of nonrecourse deductions. 32

33 Belan Wagner, Wagner Kirkman Blaine Komparens & Youmans Carolyn Turnbull, CPA, MST, CGMA, Independent Tax Consultant EXAMPLES OF TAXPAYER SITUATIONS

34 34 Examples based on article from Blake Rubin, Andrea Macintosh Whiteway, and Jon G. Finkelstein, Treatment of Liabilities as Recourse or Nonrecourse in a Complex Financial World, Journal of Passthrough Entities (July-August 2010)

35 Example 1: General Partnership With State Law Recourse Liability A 50% B 50% How is the recourse loan from Y allocated to A and B? What are the tax implications if AB Partnership transfers a building and land with a FMV of $400,000 and a tax basis of $200,000 to Y in satisfaction of the $500,000 loan? AB General Partnership $500,000 recourse loan to AB Partnership Y Third- Party Lender 35

36 Example 1: ANSWER I. How is the recourse loan from Y allocated to A and B? A. Because AB is a general partnership, both A and B will be allocated $250,000 in debt basis as general partners with respect to the loan because each bears a 50% economic risk of loss with respect to their ownership interests in the general partnership. II. What are the tax implications if AB Partnership transfers a building and land with a FMV of $400,000 and a tax basis of $200,000 to Y in satisfaction of the $500,000 loan? A. $200,000 gain from sale or exchange this is the difference between AB Partnership s tax basis and the FMV of the building and land at the time of the transfer. (Section 1001) B. $100,000 CODI this is the difference between the amount of the forgiven debt less the FMV of the building and land. 36

37 Example 2: General Partnership With State Law Nonrecourse Liability How is the nonrecourse loan from Y allocated to A and B? A 50% AB General Partnership B 50% How is depreciation from the office building allocated to A and B? What are the tax implications if AB Partnership transfers the office to Y in satisfaction of the $500,000 loan? Assume the building has a FMV of $400,000 and a tax basis of $200,000 at the time of the transfer. $500,000 nonrecourse loan to AB Partnership, secured only by AB s office building Y Third- Party Lender 37

38 Example 2: ANSWER I. How is the nonrecourse loan from Y allocated to A and B? A. It is allocated between A and B (i.e., 50:50 based upon their share of partnership profits). II. How is depreciation from the office building allocated to A and B? A. Subject to the safe harbor requirements pursuant to Reg. Sec (b), nonrecourse deductions, including depreciation, are allocated in proportion to the partners interests (i.e., 50% to A, and 50% to B) in the partnership. III. What are the tax implications if AB Partnership transfers the office to Y in satisfaction of the $500,000 loan? Assume the building has a FMV of $400,000 and a tax basis of $200,000 at the time of the transfer. A. $300,000 gain recognized from sale or exchange of the building A transfer of property that secures a nonrecourse loan to the creditor in satisfaction of the loan results in a sale or exchange to the debtor under Sec. 1001, equal to the difference between the debtor s adjusted basis in the property and the adjusted issue price of the debt. 38

39 Example 3: General Partnership With State Law Exculpatory Liability A 50% AB General Partnership $500,000 recourse loan to AB Partnership, but exculpatory to A and B B 50% Y Third- Party Lender` Is the loan treated as a recourse or nonrecourse loan under 1001? How about 752? How is the loan from Y allocated to A and B? How is depreciation from the office building allocated to A and B? What are the tax implications if AB Partnership transfers the office to Y in satisfaction of the $500,000 loan? Assume the building has a FMV of $400,000 and a tax basis of $200,000 at the time of the transfer. 39

40 Example 3: ANSWER I. Is the loan treated as a recourse or nonrecourse loan under 1001? How about 752? A. Under 1001, the loan is recourse to the partnership. B. Under 752, the loan is nonrecourse to the partners because it is exculpatory to A and B. Under an economic risk of loss analysis, the partners would not be liable under this loan. II. How is the loan from Y allocated to A and B? A. It will be allocated based upon their profits interests. III. How is depreciation from the office building allocated to A and B? A. Subject to the safe harbor requirements pursuant to Reg. Sec (b), nonrecourse deductions, including depreciation, are allocated in proportion to the partners interests in the partnership. 40

41 Example 3: ANSWER (Continued) IV. What are the tax implications if AB Partnership transfers the office to Y in satisfaction of the $500,000 loan? Assume the building has a FMV of $400,000 and a tax basis of $200,000 at the time of the transfer. A. $200,000 gain recognized from sale or exchange of the building this is the difference between AB Partnership s tax basis and the FMV of the building and land at the time of the transfer. ( 1001) 1. The gain from the sale or exchange will be allocated to A and B pursuant to the partners interests in the partnership, unless otherwise provided. B. $100,000 CODI this is the difference between the amount of the forgiven debt and the FMV of the building and land. 1. The income from the sale or exchange will be allocated to A and B pursuant to the partners interests in the partnership, unless otherwise provided. 41

42 Example 4: Limited Partnership With State Law Recourse Liability A 10% general partner AB Limited Partnership $500,000 recourse loan to AB Partnership. A, as the general partner, is fully liable for repayment of the loan. B 90% limited partner Y Third- Party Lender Is the loan treated as a recourse or nonrecourse loan under 1001? How about 752? How is the loan from Y allocated to A and B? Assume that the loan proceeds from Y are used to purchase an office building, which is AB s only asset. How is depreciation from the office building allocated to A and B? What are the tax implications if AB Partnership transfers the office to Y in satisfaction of the $500,000 loan? Assume the building has a FMV of $400,000 and a tax basis of $200,000 at the time of the transfer. 42

43 Example 4: ANSWER I. Is the loan treated as a recourse or nonrecourse loan under 1001? How about 752? A. Under 1001, this is a recourse loan to the partnership. B. Under 752, this is a recourse loan to Partner A because A bears economic risk of loss. II. How is the loan from Y allocated to A and B? A. It is allocated 100% to Partner A because A bears economic risk of loss. B. None of the loan is allocated to Partner B. 43

44 Example 4: ANSWER (Continued) III. Assume that the loan proceeds from Y are used to purchase an office building, which is AB s only asset. How is depreciation from the office building allocated to A and B? A. Depreciation is allocated to A and B in accordance with the partnership agreement provided the allocation has substantial economic effect under Reg B. Based on the facts in this example, an allocation of 10% of the depreciation to A and 90% of the depreciation to B will likely not have substantial effect if the allocation would create a deficit balance in B s capital account. 1. A qualified income offset provision in the partnership agreement will not cause the allocation to have substantial economic effect because the allocation of depreciation to B would not unexpectedly cause B s capital account to go negative. 2. Neither a partnership minimum gain chargeback nor partner minimum gain chargeback provision in the partnership agreement would apply because the debt is neither partnership nonrecourse debt nor partner nonrecourse debt. 44

45 Example 4: ANSWER (Continued) IV. What are the tax implications if AB Partnership transfers the office to Y in satisfaction of the $500,000 loan? Assume the building has a FMV of $400,000 and a tax basis of $200,000 at the time of the transfer. A. $200,000 gain from sale or exchange of the office this is the difference between AB Partnership s tax basis and the FMV of the building and land at the time of the transfer. ( 1001) 1. The gain from the sale or exchange of the office will be allocated in accordance with the partnership agreement provided the allocation has substantial economic effect. B. $100,000 CODI this is the difference between the amount of the forgiven debt and the FMV of the building and land. 1. The CODI is allocated in accordance with the partnership agreement provided the allocation has substantial economic effect. 45

46 Slide Intentionally Left Blank

47 Example 5: Limited Partnership With State Law Nonrecourse Liability Guaranteed By Partner A 10% general partner AB Limited Partnership $500,000 nonrecourse loan to AB Partnership, secured solely by AB s office building. A guarantees the full amount of the debt. B 90% limited partner Y Third- Party Lender Is the loan treated as a recourse or nonrecourse loan under 1001? How about 752? How is the loan from Y allocated to A and B? Assume that the loan proceeds from Y are used to purchase an office building, which is AB s only asset. How is depreciation from the office building allocated to A and B? What are the tax implications if AB Partnership transfers the office to Y in satisfaction of the $500,000 loan? Assume the building has a FMV of $400,000 and a tax basis of $200,000 at the time of the transfer. 47

48 Example 5: ANSWER I. Is the loan treated as a recourse or nonrecourse loan under 1001? How about 752? A. Under 1001, this is a partnership nonrecourse debt. B. This debt is a recourse liability under 752. The debt is recharacterized as a partner nonrecourse loan to A, however, because the loan is nonrecourse to the partnership and A bears economic risk of loss based upon A s guaranty of the loan. II. How is the loan from Y allocated to A and B? A. The loan is allocated 100% to A. A guaranteed the loan and therefore bears the economic risk of loss for the debt. 48

49 Example 5: ANSWER (Continued) III. Assume that the loan proceeds from Y are used to purchase an office building, which is AB s only asset. How is depreciation from the office building allocated to A and B? A. If a partner bears the economic risk of loss of a partnership nonrecourse debt, it is recharacterized as a partner nonrecourse debt and any nonrecourse deductions attributable to that debt must be allocated to the partner who bears its economic risk of loss, or among all partners who bear economic risk of loss according to the ratio in which they bear that risk of loss. (Reg (b)(4); Reg (i).) Partner A guaranteed the debt that is nonrecourse to the partnership and therefore bears the economic risk of loss even though the debt was originally a nonrecourse debt. Thus, Partner A will be allocated any nonrecourse deductions attributable to that debt. 49

50 Example 5: ANSWER (Continued) IV. However, assume that Partner A did not guaranty the loan and the loan proceeds from Y are used to purchase an office building, which is AB s only asset. How is depreciation from the office building allocated to A and B? A. Depreciation from the partnership nonrecourse debt will be allocated in accordance with the partners interests in the partnership. These allocations will be made in accordance with a partners interests in the partnership if the following rules are followed: 1. Capital accounts are properly maintained. 2. Allocations of deductions attributable to nonrecourse debt throughout the term of the partnership are reasonably consistent with some other significant partnership item attributable to the property creating the nonrecourse debt. 3. Either the partner has an obligation to eliminate the deficit balance of his capital account on liquidation of the partnership or of his interest or the partnership agreement contains a minimum gain chargeback. 4. All other material allocations made by the partnership are in accordance with the regulations under Section 704(b). 50

51 Example 5: ANSWER (Continued) V. What are the tax implications if AB Partnership transfers the office to Y in satisfaction of the $500,000 loan? Assume the building has a FMV of $400,000 and a tax basis of $200,000 at the time of the transfer. A. $300,000 gain from sale or exchange of the office A transfer of property that secures a nonrecourse loan to the creditor in satisfaction of the loan results in a sale or exchange to the debtor under 1001, equal to the difference between the debtor s adjusted basis in the property and the adjusted issue price of the debt. B. This gain is subject to the partner minimum gain chargeback provisions and would be allocated 100% to A. 51

52 Example 6: LLC With State Law Nonrecourse Liability 50% member A AB LLC $500,000 nonrecourse loan to AB LLC, secured solely by AB LLC s office building B 50% member Y Third- Party Lender Is the loan treated as a recourse or nonrecourse loan under 1001? How about 752? How is the loan from Y allocated to A and B? Assume that the loan proceeds from Y are used to purchase an office building, which is AB s only asset. How is depreciation from the office building allocated to A and B? What are the tax implications if AB Partnership transfers the office to Y in satisfaction of the $500,000 loan? Assume the building has a FMV of $400,000 and a tax basis of $200,000 at the time of the transfer. 52

53 Example 6: Answer I. Is the loan treated as a recourse or nonrecourse loan under 1001? How about 752? A. It is nonrecourse under both B. The debt is nonrecourse debt for purposes of 752. II. How is the loan from Y allocated to A and B? A. The debt is partnership nonrecourse debt. Partnership nonrecourse liabilities are generally allocated to the partners according to their interests in partnership profits. See Reg III. Assume that the loan proceeds from Y are used to purchase an office building, which is AB s only asset. How is depreciation from the office building allocated to A and B? A. Subject to the safe harbor requirements pursuant to Reg (e), nonrecourse deductions, including depreciation, are generally allocated in proportion to the members interests in the partnership. 53

54 Example 6: Answer (Continued) IV. What are the tax implications if AB Partnership transfers the office to Y in satisfaction of the $500,000 loan? Assume the building has a FMV of $400,000 and a tax basis of $200,000 at the time of the transfer. A. $300,000 gain from sale or exchange of the office A transfer of property that secures a nonrecourse loan to the creditor in satisfaction of the loan results in a sale or exchange to the debtor under 1001, equal to the difference between the debtor s adjusted basis in the property and the adjusted issue price of the debt. B. The gain would generally be allocated to A and B in accordance with their interests in partnership profits, subject to the partnership minimum gain chargeback provisions under Reg (f). 54

55 Example 7: LLC With State Law Recourse Liability 50% member A AB LLC $500,000 recourse loan to AB LLC, secured by all of AB LLC s assets B 50% member Y Third- Party Lender Is the loan treated as a recourse or nonrecourse loan under 1001? How about 752? How is the loan from Y allocated to A and B? Assume that the loan proceeds from Y are used to purchase an office building, which is AB s only asset. How is depreciation from the office building allocated to A and B? What are the tax implications if AB Partnership transfers the office to Y in satisfaction of the $500,000 loan? Assume the building has a FMV of $400,000 and a tax basis of $200,000 at the time of the transfer. 55

56 Example 7: Answer I. Is the loan treated as a recourse or nonrecourse loan under 1001? How about 752? A. The loan is recourse for purposes of B. The loan is nonrecourse debt for purposes of 752. II. How is the loan from Y allocated to A and B? A. The loan is partnership nonrecourse debt. A partnership nonrecourse liability is generally allocated in accordance with the members interests in partnership profits. See Reg III. Assume that the loan proceeds from Y are used to purchase an office building, which is AB s only asset. How is depreciation from the office building allocated to A and B? A. Subject to the safe harbor requirements pursuant to Reg (e), partnership nonrecourse deductions, including depreciation, are allocated in proportion to the members interests in the LLC. 56

57 Example 7: Answer (Continued) IV. What are the tax implications if AB Partnership transfers the office to Y in satisfaction of the $500,000 loan? Assume the building has a FMV of $400,000 and a tax basis of $200,000 at the time of the transfer. A. $200,000 gain from sale or exchange of the office this is the difference between AB Partnership s tax basis and the FMV of the building and land at the time of the transfer. ( 1001) 1. The gain from the sale or exchange will generally be allocated to A and B in accordance with their profits interests in the partnership, subject to the partnership minimum gain chargeback provisions under Reg (f). B. $100,000 CODI this is the difference between the amount of the forgiven debt and the FMV of the building and land. 1. This income will generally be allocated to A and B in accordance with their profits interests in the partnership, subject to the partnership minimum gain chargeback provisions under Reg (f). 57

58 Example 8: LLC With State Law Nonrecourse Liability Guaranteed By Member 50% member A AB LLC $500,000 nonrecourse loan to AB LLC, secured solely by AB LLC s office building. A guarantees full repayment of the loan. B 50% member Y Third- Party Lender Is the loan treated as a recourse or nonrecourse loan under 1001? How about 752? How is the loan from Y allocated to A and B? Assume that the loan proceeds from Y are used to purchase an office building, which is AB s only asset. How is depreciation from the office building allocated to A and B? What are the tax implications if AB Partnership transfers the office to Y in satisfaction of the $500,000 loan? Assume the building has a FMV of $400,000 and a tax basis of $200,000 at the time of the transfer. 58

59 Example 8: Answer I. Is the loan treated as a recourse or nonrecourse loan under 1001? How about 752? A. The loan is nonrecourse for purposes of B. The loan is recourse debt for purposes of 752. II. How is the loan from Y allocated to A and B? A. The loan is partner nonrecourse debt to A because A bears the risk of loss for a partnership nonrecourse liability. A partner nonrecourse liability is allocated to the partner who bears the economic risk of loss, which is A. III. Assume that the loan proceeds from Y are used to purchase an office building, which is AB s only asset. How is depreciation from the office building allocated to A and B? A. Partner nonrecourse deductions, including depreciation, are allocated to the partner who bears the economic risk of loss. Thus, depreciation is allocated 100% to A. 59

60 Example 8: Answer (Continued) IV. What are the tax implications if AB Partnership transfers the office to Y in satisfaction of the $500,000 loan? Assume the building has a FMV of $400,000 and a tax basis of $200,000 at the time of the transfer. A. $300,000 gain from sale or exchange of the office A transfer of property that secures a nonrecourse loan to the creditor in satisfaction of the loan results in a sale or exchange to the debtor under 1001, equal to the difference between the debtor s adjusted basis in the property and the adjusted issue price of the debt. B. The gain is subject to the partner minimum gain chargeback rules under Reg Thus, the gain would be allocated 100% to A. 60

61 Slide Intentionally Left Blank

62 Example 9: LLC With State Law Recourse Liability Guaranteed By Member 50% member A AB LLC $500,000 recourse loan to AB LLC; A guarantees full repayment of the loan. B 50% member Y Third- Party Lender Is the loan treated as a recourse or nonrecourse loan under 1001? How about 752? How is the loan from Y allocated to A and B? Assume that the loan proceeds from Y are used to purchase an office building, which is AB s only asset. How is depreciation from the office building allocated to A and B? What are the tax implications if AB Partnership transfers the office to Y in satisfaction of the $500,000 loan? Assume the building has a FMV of $400,000 and a tax basis of $200,000 at the time of the transfer. 62

63 Example 9: Answer I. Is the loan treated as a recourse or nonrecourse loan under 1001? How about 752? A. The loan is recourse for purposes of B. The loan is recourse debt for purposes of 752. II. How is the loan from Y allocated to A and B? A. A recourse debt is allocated to the partner who bears the economic risk of loss. Thus, the liability is allocated 100% to A. III. Assume that the loan proceeds from Y are used to purchase an office building, which is AB s only asset. How is depreciation from the office building allocated to A and B? A. Provided the allocation has substantial economic effect, depreciation is allocated in accordance with the partnership agreement. 63

64 Example 9: Answer (Continued) IV. What are the tax implications if AB Partnership transfers the office to Y in satisfaction of the $500,000 loan? Assume the building has a FMV of $400,000 and a tax basis of $200,000 at the time of the transfer. A. $200,000 gain from sale or exchange of the office this is the difference between AB Partnership s tax basis and the FMV of the building and land at the time of the transfer. ( 1001). 1. The gain would be allocated to A and B in accordance with the partnership agreement provided such allocation has substantial economic effect. B. $100,000 CODI this is the difference between the amount of the forgiven debt and the FMV of the building and land. 1. The income would be allocated to A and B in accordance with the partnership agreement provided such allocation has substantial economic effect. 64

65 Example 10: Limited Partnership With Wholly Owned LLC With State Law Recourse Liability A 50% member 100% AB LP WX LLC $500,000 recourse loan to XY LLC B 50% member Y Third- Party Lender Is the loan treated as a recourse or nonrecourse loan under 1001? How about 752? How is the loan from Y allocated to A and B? Assume that the loan proceeds from Y are used to purchase an office building, which is AB s only asset. How is depreciation from the office building allocated to A and B? What are the tax implications if AB Partnership transfers the office to Y in satisfaction of the $500,000 loan? Assume the building has a FMV of $400,000 and a tax basis of $200,000 at the time of the transfer. 65

66 Example 10: Answer I. Is the loan treated as a recourse or nonrecourse loan under 1001? How about 752? A. The characterization of the liability for purposes of 1001 is unclear. For state law purposes, the loan is recourse to WX LLC, but nonrecourse to AB, LP. B. The loan is nonrecourse debt for purposes of 752. II. How is the loan from Y allocated to A and B? A. The loan is partnership nonrecourse debt. A partnership nonrecourse liability is generally allocated in accordance with the members interests in partnership profits. See Reg

67 Example 10: Answer (Continued) III. Assume that the loan proceeds from Y are used to purchase an office building, which is AB s only asset. How is depreciation from the office building allocated to A and B? A. Subject to the safe harbor requirements pursuant to Reg (e), partnership nonrecourse deductions, including depreciation, are allocated in proportion to the members interests in the LLC. 67

68 Example 10: Answer (Continued) IV. What are the tax implications if AB Partnership transfers the office to Y in satisfaction of the $500,000 loan? Assume the building has a FMV of $400,000 and a tax basis of $200,000 at the time of the transfer. A. The answer will depend on how the liability is treated for purposes of

69 Example 10: Answer (Continued) B. The gain is taxed as follows if the liability is treated as recourse debt for purposes of 1001: 1. $200,000 gain from sale or exchange of the office this is the difference between AB Partnership s tax basis and the FMV of the building and land at the time of the transfer. ( 1001). a. Because the debt is treated as partnership nonrecourse debt for purposes of 752, the gain from the sale or exchange will generally be allocated to A and B in accordance with their profits interests in the partnership, subject to the partnership minimum gain chargeback provisions under Reg (f). 2. $100,000 CODI this is the difference between the amount of the forgiven debt and the FMV of the building and land. a. The income will generally be allocated to A and B in accordance with their profits interests in the partnership, subject to the partnership minimum gain chargeback provisions under Reg (f). 69

70 Example 10: Answer (Continued) C. The gain is taxed as follows if the liability is treated as nonrecourse debt for purposes of 1001: 1. $300,000 gain from sale or exchange of the office A transfer of property that secures a nonrecourse loan to the creditor in satisfaction of the loan results in a sale or exchange to the debtor under 1001, equal to the difference between the debtor s adjusted basis in the property and the adjusted issue price of the debt. a. Because the debt is treated as partnership nonrecourse debt for purposes of 752, the gain from the sale or exchange will generally be allocated to A and B in accordance with their profits interests in the partnership, subject to the partnership minimum gain chargeback provisions under Reg (f). 70

71 Carolyn Turnbull, McGladrey LLP AT-RISK RULES UNDER IRC SECT. 465

72 Sect. 465 At-Risk Amount I. A taxpayer is considered at risk for an activity with respect to amounts borrowed with respect to such activity. ( 465(b)(1)(B)) II. Amounts borrowed for use in an activity include: A. Debt for which the taxpayer is personally liable for repayment, and B. Debt for which the taxpayer has pledged property (other than property used in the activity) as security for the borrowed amount. 1. Amount at risk is limited to the net FMV of the collateral. 72

73 Sect. 465 At-Risk Amount (Cont.) I. Taxpayer must be primarily liable on the debt. A. Guarantees do not increase the taxpayer s amount at risk until the taxpayer repays the creditor for the amount borrowed, and the taxpayer has no remaining legal rights against the primary obligor. (Prop. Reg (d)) II. Amounts borrowed for use in an activity do not include: A. Amounts borrowed from any person who has an interest (other than as a creditor) in the activity B. Amounts borrowed from a person related to any person who has an interest (other than as a creditor) in the activity (other than the taxpayer) 73

74 Sect. 465 At-Risk Amount (Cont.) I. Only qualified nonrecourse debts are included in at-risk amount: A. Borrowed with respect to activity of holding real estate, and secured by real estate; B. Borrowed from a lender in the business of lending money and who has no interest in the activity in which the funds are used; and C. Not convertible into stock or securities. 74

75 Example: Basis And At-Risk Limitations Susan is a 10% owner in ABC LLC, which has elected to be treated as a partnership for federal income tax purposes. Her tax basis in the LLC is $25,000, consisting of a $10,000 capital contribution and $15,000 of non-qualified, nonrecourse debt. For 2011, Susan s distributive share of the LLC s loss is ($32,000). 75

76 Example: Basis And At-Risk Limitations (Cont.) 2011 Basis Limitation At-Risk Limitation Capital contribution 10,000 10,000 Non-qualified, nonrecourse debt 15, Loss allowed for 2011 (25,000) (10,000) Balance 12/31/ Carryover to 2012 (7,000) (15,000) 76

77 Example: Basis And At-Risk Limitations (Cont.) ABC, LLC has positive income for Susan s distributive share is $10, Basis Limitation At-Risk Limitation LLC income for ,000 Loss carryover from 2011 (7,000) Net income reported for ,000 3,000 Loss carryover from (3,000) Balance -12/31/12 3, Carryover to (12,000) 77

78 Example: Basis And At-Risk Limitations (Cont.) Susan sells her interest in ABC, LLC in 2013 for $8,000 cash, plus assumption of her $15,000 share of the LLC s non-qualified, nonrecourse debt. Susan will recognize a $20,000 gain. This $20,000 gain will trigger release of the ($12,000) 465 carryforward from

79 Treatment Of Partnership Liabilities For Partnership Income Tax Purposes Circular 230 Disclosure These materials are intended for internal discussion purposes only. To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this communication is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or any other state or local law, or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. 79

80 Carolyn Turnbull, CPA, MST, CGMA, Independent Tax Consultant Belan Wagner, Wagner Kirkman Blaine Komparens & Youmans CONCLUDING REMARKS