1. Corporate & Partner Tax Instructor: Dwight Drake Partnership Liability Allocations What’s at stake – A Reminder - Partner’s deductible losses can not exceed outside basis per 704(d). - Cash distributed in excess of outside basis triggers gain. - Increase in partner’s share of liabilities deemed contribution of cash per 752 and increase outside basis. - Decrease in partner’s share of liabilities deemed distribution of cash per 752 and reduces outside basis.

2. Corporate & Partner Tax Instructor: Dwight Drake General Allocation Rules Recourse debts: Allocate according to how losses shared. Nonrecourse debts: Allocate according to how profits shared. So why the fuss? Three complications: 1. Special allocations under 704(b) 2. Minimum gain rules of 704(b): liability exceeds basis. 3. Built-in gain rules of 704(c) on contributed property.

3. Corporate & Partner Tax Instructor: Dwight Drake Recourse Liabilities Big Question: Who bears the ultimate loss on debt? Often, determination can be made by just “eye-balling” situation. Reg. Test: Assume hypothetical (constructive) liquidation: 1. All partnership liabilities become due and payable. 2. All assets that secure debts are transferred to pay debts. 3. All other partnership assets are worthless. 4. Consider all guarantees, all terms of partnership agreement, all rights under state law and loan documents. 5. Assume all partners have means to honor obligations. 6. Then: Who must pony up to pay off debt and for how much? Recourse debt is allocated accordingly.

4. Corporate & Partner Tax Instructor: Dwight Drake Nonrecourse Liabilities Partners share of nonrecourse liabilities is sum of three components: 1. Partner’s share of minimum gain determined under 704(b) Regs. If partner is allocated nonrecourse deductions with minimum gain chargeback, debt is allocated first to extent of minimum gain allocable to partner. 2. Partner’s share of 704(c) built-in minimum gain on contributed property with nonrecourse debt in excess of basis. 3. Partner’s share of “excess nonrecourse liabilities” – those remaining after first two components allocated to all partners. Four options for excess.

5. Corporate & Partner Tax Instructor: Dwight Drake Four Options for Excess Nonrecourse Liabilites 1. Allocate per specification in agreement so long as specified allocation is reasonably consistent with other significant item of gain or income that has substantial economic effect. 2. Allocate according to how deductions related to the nonrecourse liabilities are reasonable expected to be allocated over time under 704(b). 3. In case of contributed property, first allocate excess nonrecourse liability to contributing partner to extent full built-in gain exceeds minimum built-in gain – which minimum already triggered allocation to contributing partner. 4. Allocate in accordance with partner’s share of profits, considering all facts and circumstances. Bottom line: There is often some flexibility – real wiggle room.

6. Corporate & Partner Tax Instructor: Dwight Drake Problem 209 - 1 Basic Facts: A, B, C each contribute 20k to GP. Primary 704(b) test satisfied. Profits and losses allocated 40% to A & B; 20% to C. Partnership borrows 40k recourse and buys land for 100k. (a)How recourse debt allocated? According to who bears economic risk. Reg. 1.752-2(a). To determine, assume constructive liquidation of partnership where land sold for zero. 100k loss allocated 40k to A & B; 20k to C. C capital account zero; A & B negative 20, which they must pay under deficit restoration. Hence, A & B bear all lose and recourse debt allocated to them. A & B outside basis 40k; C’s is 20k. (b)Same as (a), but A,B&C contribute 10k, 20k & 30k. A capital account to minus 30, B’s to minus 20 and C’s to plus ten on hypothetical liquidation. A must restore deficit of 30k and B must restore 20k. 50k restored used to pay 40k recourse debt and 10k C balance. Per Reg. 1.752-2(b), debt allocated pro rata to A & B, with A getting 24k (40k x 30/50) and B getting 16k (40k x 20/50). Outside basis as follows: A - 34k; B - 36k; C - 30k.

7. Corporate & Partner Tax Instructor: Dwight Drake Problem 209 - 1 Basic Facts: A, B, C each contribute 20k to GP. Primary 704(b) test satisfied. Profits and losses allocated 40% to A & B; 20% to C. Partnership borrows 60k recourse and buys land for 100k. © What result in (a) if A & B are LPs with no deficit restoration, just qualified income offset? A & B can’t go negative, so on hypothetical liquidation they each allocated only 20k loss and C allocated 60k. C capital account to minus 40k, which C must restore as GP under deficit restoration. Thus, all 40k liability allocated to C. C’s outside basis goes to 60k (20k +40k). (d)Result in © if A contributes 15k stock to secure debt and all income, gain or loss on stock allocated to A? A’s capital account increased to 35k. Hypothetical loss on liquidation allocated 35k to A, 20k to B, 45k to C. C’s capital account negative 25k, which C must restore. Thus, recourse debt allocated 25k to C and 15k to A. Same result with A 15k note. Although note not increase basis until paid, A still bear economic loss because must pay.

8. Corporate & Partner Tax Instructor: Dwight Drake Problem 209 - 1 Basic Facts: A, B, C each contribute 20k to GP. Primary 704(b) test satisfied. Profits and losses allocated 40% to A & B; 20% to C. Partnership borrows 60k recourse and buys land for 100k. (e) What result in © if A personally guarantees 40k note? Depends on local law. If A guarantee relieves C of any deficit restoration liability, then entire 40k liability allocated to A. If A is subrogated to rights of lender against C for any payments on guarantee, then A’s payment obligation deemed zero. Reg. 1.752-2(b)(5). In such event, total liability allocated to C.

9. Corporate & Partner Tax Instructor: Dwight Drake Problem 209 - 2 Basic Facts: G and L form LP. G contributes 10k; L, as LP, contributes 90k. 900k nonrecourse loan used to buy building for $1 mill. - Loan has market rate interest and no principal for 10 yrs. - Depreciation 50k per yr. - Only G has deficit restoration; qualified income offset and minimum gain charge back.. -90-10 income and loss split until income equals losses, then 50-50. Switch to 50-50 not anticipated in first 10 yrs. -Partnership agreement says each partner has 50% of profits for 752 purposes. (a) How 900k nonrecourse loan allocated yr 1? On deemed liquidation where land sold for zero, neither has any economic risk for nonrecourse debt. Partnership has 100k loss, which just takes capital accounts to zero. No minimum gain because basis greater than liability. So agreement 50% provision OK because consistent with 50-50 split. Thus, 450k allocated to each.

10. Corporate & Partner Tax Instructor: Dwight Drake Problem 209 - 2 (b) How liability allocated at end of year 3? 150k depreciation reduces basis to 850k. Now minimum gain of 50k which would be recognized on constructive liquidation of assets for zero. Minimum gain allocated 90 -10 per agreement, so first 50k of liability allocated 90 - 10: 5k to G and 45k to L. Balance of nonrecourse debt (850k) allocated equally under rationale of (a). Thus, G share of liability is 430 (425 + 5) and L’s is 470 (425 + 45). © What if excess nonrecourse liability allocated 90 - 10? This permissible because consistent with other allocations that have substantial economic effect. Reg. 1.752-2(b)(3)(I). Thus 810k allocated to L and 90k allocated to G. Advantage is that there is no need to reallocate liability each year as minimum gain increases. (d) If G guarantees debt, G bears full economic risk and entire 900k viewed as recourse debt and allocated to G. Same result if G has recourse against partnership because only G has deficit restoration. L not on hook for anything. G’s low net worth not relevant; Regs assume partner will honor obligations unless plan to avoid obligation. Reg. 1.752-2(b)(6).

11. Corporate & Partner Tax Instructor: Dwight Drake Problem 209 - 2 (e) Debt guaranteed by L and L have right of reimbursement from partnership. L has no obligation because of reimbursement right, which puts entire risk on G, who has obligation to cover deficit. Hence, all 900k liability allocated to G. (f) What is answer to (a) if G is lender? Per 1.752-2©(1), if partner is lender of nonrecourse debt, that partner bears entire risk and entire liability allocated to that partner. Hence, entire 900k allocated to G.

12. Corporate & Partner Tax Instructor: Dwight Drake Problem 209 - 3 Facts: AB partnership has Bldg 1, FMV 800k, basis 300k. C becomes 1/3 partner by contributing Bldg 2, FMV 700k, basis 150k, recourse debt 300k, which partnership assumes. Partnership revalues assets upon C contribution. (a)How is 300k liability allocated? Liability allocated equally to 3 partners because they each bear 1/3 of economic loss. C is relieved of 200k liability, which is treated as cash distribution under 752. A & B outside basis each increased 100k for debt share. C has deemed money distribution in excess of 150k basis of 50k - so must book 50k gain. C’s outside basis is zero. (b)300k nonrecourse debt and partners use traditional method of allocation? Minimum gain is 150k - excess of 300k debt over 150 basis. This 150 must be allocated to C, as contributing partner. Other 150 debt may be allocated per any of methods under 1.752 -3(a)(3): 1- partners’ shares under facts and circumstances, 2- profits from excess nonrecourse liabilities per agreement if reasonably consistent with other significant valid item allocation, 3- in accordance with how nonrecourse deductions will be allocted, 4- to a partner who is allocated excess built-in gain per agreement.

13. Corporate & Partner Tax Instructor: Dwight Drake Problem 209 - 3 Facts: AB partnership has Bldg 1, FMV 800k, basis 300k. C becomes 1/3 partner by contributing Bldg 2, FMV 700k, basis 150k, recourse debt 300k, which partnership assumes. Partnership revalues assets upon C contribution. (c) C contributes 400k cash instead of Bldg 2 and partnership borrows 500k nonrecourse on Bldg 1. How is debt allocated? Built-in minimum gain is 200k (excess of 500k over 300k basis), all allocated to A & B under 704© principles. So first 200k nonrecourse debt allocated 100k each to A & B. Excess 300k debt could be allocated under any of four methods described in (b) above.