Allocation of Liabilities

1
Allocation of Liabilities

• Section 752

2
Effect of Liabilities on Basis

• Section 752(a) - As a partners percentage of
  liabilities goes up deemed cash contribution
• Section 752(b) - As a partners percentage of
  liabilities goes down deemed cash distribution

3
What is the definition of a liability?

• There is no set definition in the Code
• However, it must be a valid obligation to pay
  that is legally enforceable

4
How are liabilities allocated?

• Regulations under 1.752 address this issue
• The ultimate goal is to allocate debt to the
  person who is ultimately liable to pay the debt

5
Regulation 1.752-1

• The regulations broadened the coverage of Section
  752 from partner to partner and related parties.
• Related parties are defined under Section 267(b)
  and Section 707(b)(1) but you must change the
  percentage to 80.

6
Regulation 1.752-1

• Reg. 1.752-1(e) allows the netting method for
  increases and decreased in liabilities in the
  same transaction.
• Reg. 1.752-1(i) separates liabilities between
  recourse and nonrecourse liabilities.

7
What is a recourse liability?

• A liability for which at least one partner bear
  the economic risk of loss
• Recourse debt is allocated to the partner who
  bears the economic risk of loss.

8
Who bears the economic risk of loss?

• A partner who is obligated to make payment on the
  debt 1.752-2(b)(1)
• A partner who is a creditor 1.752-2(c)
• A partner who guarantees the interest on a
  nonrecourse debt
• A partner who pledges personal property as
  security

9
Allocation of Liabilities Under the Obligation to
Pay

• Liabilities are allocated using a constructive
  liquidation.
• Under the constructive liquidation the
  partnership must follow a five step process

10
Constructive Liquidation

• All liabilities become payable in full
• All assets have a zero value
• The partnership disposes of all assets for their
  value (0). This creates a loss equal to basis.
• All losses are allocated to the partners.
• Partnership liquidates.

11
Allocation of Recourse Debt

• After the constructive liquidation the partner
  that must restore a negative capital account is
  the partner that the liability is allocated.
• Recourse debt is only allocated to general
  partners

12
Example

• Two partners each own 50 of the partnership.
  Both contribute 10 cash to the partnership and
  the partnership borrows 80. With the 100 the
  partnership now has it buys property. How do we
  allocate the debt to the partners.

13
Twist on the example

• In this case A is a 10 partner while B is a 90
  partner. A contributed cash of 10 and B
  contributed property with a FMV of 90 and a
  basis of 10. The partnership borrows 80 to buy
  additional property. How is the debt allocated?

14
Solution Haberdashery Products

• Under a constructive liquidation analysis,
  Haberdashery is deemed to sell all its assets for
  no consideration, which would result in the
  recognition of a 1,000,000 loss.
• Messrs. Mincey and Schmidt (as limited partners)
  would be allocated 80,000 and 70,000 of the
  loss respectively (to reduce their capital
  accounts to zero), and Messrs. Oliver and
  Carpenter would each be allocated 425,000 of the
  loss.
• Each general partner would be required to restore
  the deficit balance in his or her capital account
  to satisfy the 600,000 recourse liabilities.
  Thus, Mr. Olivers share of recourse liabilities
  equals 325,000 and Mr. Carpenters share of
  liabilities equals 275,000.

15
What is a Nonrecourse Debt?

• A debt for which no partner would be obligated to
  make any additional payments with respect to the
  debt.

16
How is nonrecourse debt allocated?

• Per Section 1.752-3 nonrecourse liabilities are
  allocated in the following manner
• Partners share of minimum gain
• Gain allocated under Section 704(c)
• Any excess is allocated based on profit
  percentages.

17
How is nonrecourse debt allocated?

• New regulations allow partners to allocate
  additional Section 704(c) gain to contributing
  partners if the amount of debt they are allocated
  is reduced because of the Section 704(b) minimum
  gain layer
• Nonrecourse debt is allocated to both general and
  limited partners

18
Solution NJ Partnership

• a. Christophers outside basis is computed as
  follows.
• Adjusted basis of contributed property
  240,000
• Share of existing recourse liabilities
  75,000
• Share of recourse mortgage 50,000
• Relief of recourse mortgage
  (200,000)
• Outside basis
  165,000
• b. Christophers outside basis is computed as
  follows.
• Adjusted basis of contributed property
  10,000
• Share of recourse liabilities 75,000
• Share of recourse mortgage
  50,000
• Relief of recourse mortgage (200,000)
• Outside basis
  -0-
• Christopher recognizes the 65,000 excess relief
  of the recourse mortgage as section 731(a) gain.

19
Solution NJ Partnership

• c. Christophers outside basis is computed as
  follows.
• Adjusted basis of contributed property
  240,000
• Share of recourse liabilities
  75,000
• Share of nonrecourse mortgage (third-tier
  allocation) 50,000
• Relief of nonrecourse mortgage
  (200,000)
• Outside basis
  
  165,000
• d. Christophers outside basis is computed as
  follows.
• Adjusted basis of contributed property
  10,000
• Share of recourse liability
  75,000
• Share of nonrecourse mortgage
• second-tier allocation
  190,000
• third-tier allocation
  
  2,500
• Relief of nonrecourse mortgage
  (200,000)
• Outside basis 77,500

20
Solution NJ Partnership

• 2. Each other partners outside basis would
  decrease by 12,500 (12,500 allocation of the
  nonrecourse mortgage liability - 25,000
  decreased share of existing recourse
  liabilities).