Recourse and Non-Recourse Liability in Partnerships Minimizing the Tax Impact of Partner Liability and Debt Allocations Under Sections 752 and 704

Transcription

1 Presenting a live 110-minute teleconference with interactive Q&A Recourse and Non-Recourse Liability in Partnerships Minimizing the Tax Impact of Partner Liability and Debt Allocations Under Sections 752 and 704 WEDNESDAY, OCTOBER 17, pm Eastern 12pm Central 11am Mountain 10am Pacific Today s faculty features: Andrew W. Ratts, Partner, Winston & Strawn, Chicago Jon R. Stefanik, Buckingham Doolittle & Burroughs, Akron, Ohio 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.

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5 Recourse And Non-Recourse Liability In Partnerships Seminar Oct. 17, 2012 Andrew W. Ratts, Winston & Strawn Jon R. Stefanik, Buckingham Doolittle & Burroughs

6 Today s Program Overview Of Sect. 752 Liabilities And Interplay With Sect. 704 Allocations [Andrew W. Ratts] Slide 8 Slide 26 Distinguishing Recourse And Non-Recourse Liabilities [Jon R. Stefanik] Slide 27 Slide 38 Recent Transactions And Cases Interpreting Sect. 752 Allocations [Andrew W. Ratts] Slide 39 Slide 63 Planning Strategies And Techniques [Jon R. Stefanik] Slide 64 Slide 72

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. 7

8 Andrew W. Ratts, Winston & Strawn OVERVIEW OF SECT. 752 LIABILITIES AND INTERPLAY WITH SECT. 704 ALLOCATIONS

9 Allocation Of Partnership Income: Introduction In determining its income tax, each partner must take into account separately its distributive share (whether any cash or property is distributed) of partnership items of income, gain, loss, deduction and credit. 702 A partner s distributive share of book income is determined by 704(b) and the regulations thereunder. A partner s distributive share of taxable income generally follows its 704(b) share, but with modifications under 704(c). 9

10 Allocation Of Income: Sect.704(b) Treas. Reg (b) provides the rules to determine whether an allocation provided in the partnership agreement will be respected for tax purposes as either: (i) Having substantial economic effect, or (ii) Being in accordance with the partners interest in the partnership. 10

11 Allocation Of Taxable Income: Sect. 704(c) Income, gain, loss and deduction with respect to property contributed by a partner to a partnership shall, under regulations, be shared among the partners so as to take account of the variation between the basis of the property to the partnership and its FMV at the time of contribution. ( 704(c)(1)(A)) Treas. Reg provides three methods for eliminating book/tax disparities: The traditional method, the traditional method with curative allocations, and the remedial method. The partnership is also permitted to use any reasonable method of making the allocations. The partnership is not limited to the three methods described in the regulations. The choice of method may be made on a property-by-property basis. 11

12 Allocation Of Taxable Income: Sect. 704(c), Cont. Traditional method - Tax allocations to the non-contributing partner of cost recovery deductions with respect to the 704(c) property must equal book allocations of those deductions, to the extent possible. The ceiling rule provides that total income, gain, loss or deduction may not exceed the partnership s total income, gain, loss or deduction recognized for tax purposes. 12

13 Allocation Of Taxable Income: Sect. 704(c), Cont. Example: Traditional method 13

14 Allocation Of Taxable Income: Sect. 704(c), Cont. Traditional method with curative allocations If the ceiling rule applies, then the partnership looks for another tax item of the same amount and character as the item limited by the ceiling rule. Two elements: Remedial allocation method The partnership steps into the shoes of the contributing partner for the portion of the book value equal to the adjusted tax basis. The remainder of the book value (book value less tax basis) is recovered as if it were a newly purchased asset placed in service at the time of the contribution. 14

15 Allocation Of Taxable Income: Sect. 704(c), Cont. Example: Traditional method with curative allocations Use the same facts given for the traditional method, but assume that the partnership also has $4,000 of ordinary income to be allocated. 15

16 Allocation Of Taxable Income: Sect. 704(c), Cont. Example: Remedial allocation method 16

17 Outline Of Sect. 752 Increase in partner s liabilities ( 752(a) and Reg (b)) Considered a contribution of money by the partner to the partnership Includes: Any increase in the partner s share of partnership liabilities Any increase in the partner s individual liabilities by reason of the partner s assumption of partnership liabilities Decrease in partner s liabilities ( 752(b) and Reg (c)) Considered a distribution of money by the partner from the partnership Includes: Any decrease in the partner s share of partnership liabilities. Any decrease in the partner s individual liabilities by reason of the partnership s assumption of the partner s individual liabilities 17

18 Outline Of Sect. 752 (Cont.) Liability to which property is subject ( 752(c)) Considered a liability of the owner of the property to the extent of the FMV of the underlying property Sale or exchange of a partnership interest ( 752(d) and Reg (h)) Liabilities are treated in the same manner as liabilities in connection, with the sale or exchange of property not associated with partnerships. The reduction in the transferor partner s share of partnership liabilities is treated as an amount realized under 1001 and the regulations thereunder. 18

19 Liability Defined An obligation is a liability only if, when, and to the extent that incurring the obligation: Creates or increases the basis of any obligor s assets (including cash), Gives rise to an immediate deduction of the obligor, or Gives rise to an expense that is not deductible in computing the obligor s taxable income and is not properly chargeable to capital. An obligation is a fixed or contingent obligation to make payment, without regard to whether the obligation is otherwise taken into account for purposes of the Code. 19

20 Recourse/Non-Recourse Liabilities Definition of recourse liability Partnership liability to the extent any partner or related person bears the economic risk of loss for that liability under Reg Definition of a non-recourse liability Partnership liability to the extent that no partner or related person bears the economic risk of loss for that liability under Reg Non-recourse liabilities are allocated in three tiers: The partner s share of partnership minimum gain under 704(b); The amount of any taxable gain that would be allocated to the partner under Sect. 704(c) (or in the same manner as Sect. 704(c) in connection with a revaluation of partnership property), if the partnership disposed of all partnership property in full satisfaction of the liabilities and for no other consideration; and The partner s share of the partnership s excess recourse liabilities (flexibility!). 20

21 Allocations Attributable To Non- Recourse Liabilities (Reg ) Deductions attributable to partnership nonrecourse liabilities ( nonrecourse deductions ) cannot have economic effect. Non-recourse deductions must be allocated in manner deemed to be in accordance with the partners interests in the partnership, as provided in Reg (e). Partnership agreement must comply with capital account maintenance rules. Partnership agreement allocates non-recourse deductions in a manner that is reasonably consistent with allocations that have substantial economic effect of some other significant item attributable to the property securing the non-recourse liabilities. Partnership agreement must contain a minimum gain chargeback provision. 21

22 Allocations Attributable To Non-Recourse Liabilities (Reg ), Cont. 1 st tier/minimum gain layer: Partnership minimum gain generally equals the recapture of non-recourse deductions as a gain that the partnership would realize if it disposed of property subject to a nonrecourse liability, for no consideration other than full satisfaction of that liability. Increases and decreases in minimum gain from separate properties are netted for a partnership taxable year. Net increase or decrease in partnership minimum gain for any partnership taxable year is determined by comparing the partnership minimum gain on the last day of the immediately preceding taxable year with the partnership minimum gain on the last day of the current taxable year. 22

23 Allocations Attributable To Non-Recourse Liabilities (Reg ), Cont. 2 nd tier/ 704(c) layer: Generally equals the gain the partnership would realize if it disposed of property subject to a non-recourse liability, for no consideration other than full satisfaction of that liability 704(c) method (traditional, curative or remedial) is relevant. Reverse 704(c) is included. 23

24 Allocations Attributable To Non-Recourse Liabilities (Reg ), Cont. 3 rd tier/excess layer: (Very) generally in accordance with partnership profits or in accordance with facts and circumstances Option 1: As such profits interests are specified, provided that the specified profits interests are reasonably consistent with the allocations of some other significant item of partnership income or gain Option 2: In the manner in which it is reasonably expected that the deductions attributable to such non-recourse liability will be allocated (taking into account 704(c)) Option 3: Up to the amount of the remaining 704(c) gain (including reverse 704(c) gain) not taken into account under the 2 nd tier, with any remaining amount under another method A different method may be applied each year. 24

25 Allocations Attributable To Recourse Liabilities ( Partner Non-Recourse Deductions ) Deductions attributable to partnership liabilities for which a partner or related person bears the economic risk of loss must be allocated to that partner. Ordering rules Partner non-recourse debt minimum gain chargeback. Limited DRO and limited guarantees Creation of recourse obligation Obligation must be enforceable. Plan to avoid or circumvent obligation DRO/guarantee may be eliminated or reduced. May not affect prior allocations Does not result in remaining impermissible negative capital account 25

26 Possible Changes To Current Regulations Treasury is working on new 752 and 707 rules, which are expected to address the following topics: Further guidance on allocating 3 rd tier/excess non-recourse liabilities (including whether a preferred return is a significant item) Guidance on allocating partner non-recourse liabilities when partners have overlapping economic risk of loss Additional factors illustrating the line under the anti-abuse rule in Reg (j), including guidance on how much net value an indemnitor needs for its guarantee or indemnity to be respected 26

27 Jon R. Stefanik, Buckingham Doolittle & Burroughs DISTINGUISHING RECOURSE AND NON-RECOURSE LIABILITIES

28 Recourse Vs. Non-Recourse Relevance Of Classification Sections 1001/108 Sales and exchange vs. COD income Sect. 752 Basis of partnership interest Sect. 704 Allocations of non-recourse deductions, e.g. Sect. 465 At-risk basis 28

29 Recourse Classification Of Liabilities (State Law Purposes) Creditor has recourse to all of debtor s assets to satisfy the underlying debt. Non-recourse Obligation is secured by specific property. Creditor is limited to such property to satisfy the obligation. 29

30 Sect No statutory definition of recourse/non-recourse No regulatory definition State law definition understood to control Effect of distinction (see example, next two slides) 30

31 Example 1 A purchases a tractor from B for $1,000 cash and a seller note of $9,000. A becomes delinquent at a time when the balance due on the note is $7,000, A s basis in the tractor is $3,000, and the FMV of the tractor is $5,000. B forecloses and accepts return of the tractor in full payment of the note. 31

32 Example 1 (Cont.) If the note is non-recourse Full $7,000 note balance is treated as amount realized, and A has gain of $4,000 ($7,000 amount realized less $3,000 basis). If the note is recourse A is treated as having sold the tractor for $5,000 (its FMV), resulting in $2,000 of Sect gain. A also has $2,000 of COD income (excess of note balance over FMV of tractor). 32

33 Sections 465/704/752 Partnership definitions of recourse and non-recourse apply 465 Partner is not at-risk under Sect. 465 for his share of non-recourse debt. Exception for qualified NR financing 752 Allocation of debt among partners 704 Deductions funded by debt attributable to partner(s) to whom debt is allocated 33

34 Recourse Classification Of Liabilities (Partnership Rules) A partner or a related person bears the economic risk of loss for the liability. Non-recourse No partner or a related person bears the economic risk of loss for the liability. Allocated in accordance with three tiers 34

35 Economic Risk Of Loss Constructive liquidation test A partner bears the economic risk of loss with respect to a liability, to the extent the partner would have to pay the liability if the partnership liquidated and all of the partnership s assets were worthless. Guarantees and other arrangements In determining who must pay a partnership liability, consideration is given to all guarantees and other contractual arrangements among the parties, and to other relevant facts and circumstances. Guarantor is deemed able to pay irrespective of net worth. 35

36 Disregarded Entities Special rule applies where a partner holds his partnership interest through a DE. Partner is treated as being at risk of loss only to the extent of the net value of the DE. This rule does not apply when the partner is otherwise liable for the obligation (e.g., via a guarantee). 36

37 DE: Example A owns 100% of LLC; LLC is a DE. LLC and B each contribute $100k to AB. AB borrows $200k. LLC has a DRO, but B does not. LLC has no net value. For tax purposes, A is treated as direct owner of LLC s interest in AB. Even though A has a DRO (through LLC), there no EROL, because state law limits his exposure to LLC s debts. Thus, debt is NR. 37

38 Interplay Of Sections Does state-law or Sect. 752 definition apply? See Great Plains Gasification Associates v. Comm r, TC Memo TP argues for recourse classification so that COD income can be excluded under Sect Tax Court finds that the liability is non-recourse, because no partner bears risk of loss (i.e., Sect. 752 standard applied). Even though creditor had recourse to all of the LLCs assets (i.e., the state law standard) 38

39 Andrew W. Ratts, Winston & Strawn RECENT TRANSACTIONS AND CASES INTERPRETING SECT. 752 ALLOCATIONS

40 Leveraged Partnership Structure (1) Cash equal to 90% of business value and (2) 10% equity interest in LLC Seller Sub 6 Business Assets LLC Assets Partner % Equity Interest in LLC 1. Sub and Partner form LLC. 2. Sub contributes business assets to the LLC in exchange for (1) a cash payment equal to, for example, 90% of the value of the contributed business assets and distributes the cash to Sub tax-free. 3. Partner contributes assets in exchange for a 90% equity stake in the LLC. 4. The LLC incurs debt (secured by the LLC s assets) in an amount equal to 90% of the contributed business assets and distributes the cash to Sub tax-free (see Step 2 above). 5. Sub guarantees debt of the LLC equal to the amount of cash Sub receives. 6. Sub distributes 70-75% of cash to the Seller. Cash equal to 90% of Business value 4 Debt Instrument Guarantee 5 Debt Market 40

41 G-I Holdings Mixing Bowl In re: G-I Holdings, Inc. (D.N.J. 2009) GAF Citibank Rhone-Poulenc Class A LP interest GP interest $9.8M Class B LP interest Surfactant business assets ($480M) Cash and assets ($480M) RPSSLP 41

42 G-I Holdings Mixing Bowl (Cont.) $460M Credit Suisse Pledge of Class A LP interest GAF RPSSLP Class A priority return (equal to interest on loan) Rhone-Poulenc Guarantee of Class A priority return and additional financial obligations under the partnership agreement 42

43 Partnership Anti-Abuse Subchapter K is intended to permit taxpayers to conduct joint business activity through a flexible economic arrangement without incurring an entity-level tax. Implicit in this intent are three requirements: The partnership must be bona fide and used for a substantial business purpose, The transaction must be respected under a substance over form analysis, and The resulting tax consequences must clearly reflect income (or else the distortion must be clearly contemplated by the applicable provision). Teas. Reg (b) Does compliance with regulatory provisions of sections 707 and 752 mean partnership anti-abuse rule does not apply? 43

44 IRS Response To Levpar Transactions CCA (Aug. 8, 2002) Facts: Taxpayer s subsidiary, Y, contributed assets to a partnership, Z. Z borrowed money from a syndicate of banks and made a special distribution to Y. Y then distributed this amount as a dividend to the taxpayer. Y guaranteed Z s liability, increasing its basis in its interest in Z (which allowed Y to avoid recognizing income on the distribution from Z). 44

45 C.C.A (Cont.) IRS disregarded Y s guarantee, finding that Y s lack of capital and the restrictive prerequisites for Y s performance under the guarantee suggested the existence of a plan to avoid any performance obligation from Y on the guarantee. Without the guarantee, the liability of the partnership was treated as non-recourse, which generally caused the transaction to be treated as a disguised sale. 45

46 C.C.A (Cont.) The IRS also sought to disregard the transaction on the following grounds: Partnership anti-abuse rule: Transaction was entered into with a principal purpose of reducing the partners federal tax liability. Substance-over-form: Taxpayer effectively parted with the benefits and burdens of the assets while receiving cash equal to the value of the assets. Thus, taxpayer should be taxed in accordance with the substance of the transaction (a sale) and not its form (contribution and distribution). Sham partnership: Facts did not show that taxpayer and other nominal partner in good faith and acting with a business purpose intended to join together in the conduct of a business. 46

47 Canal Corp. v. Commissioner, 135 T.C. No. 9 (2010) The court held that the formation of a joint venture between a subsidiary of Chesapeake Corp. (now known as Canal Corp.), and Georgia Pacific (GP) was actually a disguised sale under Sect. 707(a)(2)(B). As a result, Chesapeake had to include an additional $524 million of income on its consolidated return. 47

48 Canal Corp. vs. Commissioner (Cont.) Wisconsin Tissue Mills Inc. (WISCO), a wholly-owned subsidiary of Chesapeake, owned and operated a commercial tissue business that Chesapeake wanted to get rid of. 48

49 Canal Corp. Structure WISCO and GP formed Georgia Pacific Tissue LLC. GP contributed its tissue business assets, with an agreed value of $376.4 million, in exchange for a 95% interest. WISCO contributed its tissue business assets, with an agreed value of $775 million, in exchange for a 5% interest. On the contribution date, the LLC borrowed $755.2 million from BoA and immediately distributed the borrowed funds to WISCO as a special distribution. WISCO received a should opinion from PwC regarding the taxfree nature of the transaction. 49

50 WISCO s Indemnity GP guaranteed repayment of the loan, and WISCO agreed to indemnify GP in the event GP made payment on its guarantee, subject to certain limitations. Indemnity was added as a tax, rather than business, requirement. Limitations on the indemnity included: WISCO, not Chesapeake, was chosen as the indemnitor, so that only the WISCO assets would be at risk. Indemnity only covered the loan s principal, not interest. Indemnity required GP to first proceed against the LLC s assets before demanding indemnification from WISCO. If WISCO was required to make a payment under the indemnity, WISCO would receive an increased interest in the LLC proportionate to any payment made under the indemnity. WISCO was not required to maintain a certain net worth. 50

51 WISCO s Assets And Liabilities WISCO used the distributed funds to repay certain inter-company debt and to pay a dividend. WISCO also loaned $151 million to Chesapeake in exchange for a promissory note. Following the transaction, WISCO s assets consisted of the $151 million inter-company note and a corporate jet worth $6 million (or approximately 21% of the maximum exposure under the indemnity). In addition, WISCO was still subject to certain environmental liabilities and was a guarantor on a Chesapeake line of credit. 51

52 Tax Court Analysis The Tax Court presumed that a disguised sale took place, unless the facts and circumstances indicated otherwise. WISCO transferred assets to the LLC, and the LLC immediately thereafter transferred $755.2 million to WISCO. Chesapeake argued that the debt-financed transfer exception applied. Because of the indemnity, WISCO bore the entire economic risk of loss on the LLC debt. The IRS conceded that an indemnity is generally recognized as a valid contractual obligation to be considered in determining who bears the ultimate risk of loss. 52

53 Tax Court Analysis (Cont.) The IRS argued, however, that WISCO s indemnity should be disregarded under the anti-abuse rule applicable to partnership debt allocations, which provides that a partner s obligation may be disregarded if: The facts and circumstances indicate that a principal purpose of the arrangement is to eliminate the partner s risk of loss or to create a façade of the partner bearing the economic risk of loss; or The facts and circumstances evidence a plan to circumvent or avoid the obligation. Treas. Reg (j)(1), (3) Therefore, the Tax Court had to determine if the indemnity was used as a device to make it appear that WISCO had an obligation for which it did not bear the actual economic risk or loss. 53

54 Tax Court Analysis (Cont.) The Tax Court found that WISCO did not in substance bear the economic risk of loss for the partnership s loan. We find that WISCO s agreement to indemnify GP s guaranty lacked economic substance and afforded no real protection. In reaching this conclusion, the court relied on the following factors: GP did not require the indemnity; The indemnity covered only the loan s principal amount, not interest; GP was required to proceed against the LLC before it could pursue an indemnity claim against WISCO; and If WISCO made a payment under the indemnity, it would receive a proportionately increased interest in the LLC. 54

55 Tribune Newsday Transaction: Step 1 Tribune Co. CSC Holdings, Inc. (Cablevision) 100% 100% Newsday, Inc. NMG Holdings, Inc. Membership interest Newsday Holdings, LLC Membership interest Specified amount and $650 million of 8% notes Newsday assets and liabilities Newsday, LLC 55

56 Sale Of Newsday: Step 2 Tribune Co. CSC Holdings, Inc. (Cablevision) 100% 100% Newsday, Inc. NMG Holdings, Inc % membership interest % membership interest $612 million cash (distribution) $18 million cash (pre-paid rent) Newsday Holdings, LLC $650 million $650 million notes Unaffiliated Third Party Newsday, LLC 56

57 Tribune s Cubs Transaction ESOP 100% Tribune Co. 100% 100% 100% 100% Cubs LLC Premium Tickets LLC DQ LLC WGN Broadcasting Co. 100% 25% Dominican LLC CSN Chicago 57

58 Sale Of Cubs: Step 1 Tribune Co. Joe and Marlene Ricketts Grandchildren s Trust 100% Membership interest 100% Cubs Entities Cubs contributed assets Membership interest Ricketts Acquisition LLC Direct Cubs contributed assets $100 million cash Newco LLC Newco Subs 58

59 Sale Of Cubs: Step 2 Tribune Co. Ricketts Acquisition LLC 5% membership interest 95% membership interest $740 million cash Newco LLC $ million cash $ million notes Unaffiliated Third Parties 59

60 Relied-Upon Exception To Disguised Sale Rules If, as here, a partner transfers property to a partnership, and the partnership incurs a liability, and all or a portion of the proceeds of that liability are allocable to a transfer of money to the partner made within 90 days of incurring the liability Then, the transfer of money to the partner is taken into account (as proceeds of a disguised sale) only to the extent that the amount of money transferred exceeds the partner's allocable share of the partnership liability. See Treas. Reg (b)(1) 60

61 Guarantee In Bankruptcy? Newsday and Tribune have only % and 5% membership interests, respectively, in the new partnerships but are allocated substantially greater amounts of the debt pursuant to guarantees. In the Newsday deal, Tribune indemnified Cablevision for any payments made under Cablevision s guarantee of the Newsday, LLC credit facility. However, should Tribune s obligation be disregarded pursuant to Treas. Reg (j)? Tribune filed for bankruptcy on Dec. 8, Generally, Tribune s obligation should be respected so long as Tribune did not know its bankruptcy was imminent at the time it entered into the indemnification agreement. 61

62 Guarantee In Bankruptcy (Cont.) At the time of the Cubs sale, Tribune was in bankruptcy. Tribune guaranteed repayment of debt of Newco, LLC. Only provided a guarantee of collection, which requires exhaustion of all lender remedies against Newco, all other guarantors, and all collateral before Tribune is required to perform on its guarantee Should Tribune s guarantee be disregarded? See CCA (Aug. 8, 2002), discussed previously 62

63 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. 59

64 Jon R. Stefanik, Buckingham Doolittle & Burroughs PLANNING STRATEGIES AND TECHNIQUES

65 Zombie Partnership IRS Partnership Audit Technique Guide, Chap. 8 Real Estate Issues in Partnerships Partnerships which are no longer actively engaged in business but which still wander aimlessly about shedding tax benefits or postponing gain are called Zombie Partnerships. 65

66 Zombie Characteristics Zombie partnership traits: Debt Partners have negative capital accounts. Little or no assets or economic activity Asset may have been disposed while debt remains on books (attempt to defer Tufts gain). Or, interest accruals and depreciation exceed rental income; principal of debt plus accrued interest exceed value of underlying property. 66

67 COD Income Vs. Tufts Gain Depending on circumstances, TP could benefit from either NR or recourse characterization. If TP has a capital loss CF favor NR and Tufts gain IF TP is insolvent favor recourse characterization and corresponding (excludable) COD income Will 11 th hour guarantee work? IRS scrutinizes reporting of COD income vs. Tufts gain. 67

68 Audit Technique Guide Analyze all loan documents to determine whether loan was nonrecourse or recourse. If the loan is determined to be non-recourse, analyze all sales documents to determine whether there were two transactions or one interrelated transaction. If it is determined that there was one transaction, then the full amount of non-recourse debt should be treated as sales proceeds. If inspection of the partnership return indicates that COD income was reported, property decreased on the balance sheet, and a loss/very small gain/ or no gain on sale of partnership property was reported, determine whether partnership properly reported transaction. If a guarantee of non-recourse debt was made at the eleventh hour, it may not change the status of the loan from non-recourse to recourse. For example, if the guarantee provides that a partner must repay the loan only if he fights the foreclosure sale, this would be considered a contingent guarantee and would not change the loan from non-recourse to recourse. If you have an 11th hour guarantee issue, call a Partnership Technical Advisor. 68

69 Abandonment Of Interest Sect. 165(a) Allows a deduction for loss sustained during year Sect. 165(f) Losses from sale/exchange of capital asset not governed by general rule of Sect. 165(a) Sect. 741 Partnership interest is a capital asset. Sect. 752(b) Decrease in share of partnership liabilities = distribution 69

70 Abandonment: Rev. Rul If partnership liabilities are allocated to abandoning partner: 752(b) treats reduction in liabilities as a distribution, resulting in sale of a capital asset. Accordingly, resulting loss is loss from the sale or exchange of a capital asset capital loss. This treatment applies even if liabilities allocated to abandoning partner are de minimis. 70

71 Abandonment: Rev. Rul (Cont.) If no liabilities allocated to abandoning partner: No deemed distribution and thus no sale Resulting loss is thus ordinary under 165(a) General partners will have difficulty establishing ordinary loss. But see In re Kreidle, 146 B.R. 464 (general partner remained liable for liability; thus, no 752 distribution) Planning with non-participating preferred partners No liabilities allocated limit Tier 3 allocations to non-preferred partners 71

72 Establishing Abandonment Partner must prove that: He intended to abandon his interest. He undertook an affirmative act of abandonment. Intent and affirmative act are communicated to all relevant parties. A letter to partnership indicating intent to abandon and refusal to contribute or otherwise associate should suffice. 72