Slide 1

ADVANCED PARTNERSHIP DEBT ALLOCATIONS Howard E. Abrams April/May 2014

Slide 2

BASIC RULES Recourse debt is allocated in accordance with risk of loss, usually based on a hypothetical zero-value sale and liquidation. Nonrecourse debt is allocated according to three tiers: T1: The minimum gain tier. T2: The minimum 704(c) gain tier. T3: The residual (profits interests) tier. Note: There is no third category of partnership debt. If a debt is partially recourse and partially nonrecourse, it is treated as two separate debts.

Slide 3

DYNAMIC RECOURSE DEBT: EX. 1 P and Q each contribute $30 to the PQ general partnership in exchange for 50% of profits and losses. The partnership borrows $40 on a fully recourse basis. How is the debt allocated between P and Q? PQ CAOBCAOB 30 -50 -20----20---

Slide 4

DYNAMIC RECOURSE DEBT: EX. 1 Putting the debt into the outside bases as the partners share risk of loss, the books become: PQ CAOBCAOB 30 20 30503050

Slide 5

DYNAMIC RECOURSE DEBT: EX. 1 Suppose the partnership now distributes $40 of cash to partner P. The books of the venture become: PQ CAOBCAOB 30503050 -40 00 -10103050

Slide 6

DYNAMIC RECOURSE DEBT: EX. 1 But we need to consider the possibility that the distribution works a reallocation of the debt even though the amount of the debt has not changed and loss sharing ratios have not changed. PQ CAOBCAOB -10103050 -30 -40---$ 0---

Slide 7

DYNAMIC RECOURSE DEBT: EX 1 The debt has thus shifted entirely to P, and so the books actually become: PQ CAOBCAOB -10103050 20-20 -1030 Even though the distribution was made only to P, each partners outside basis declines by $20 from $50 to $30.

Slide 8

DYNAMIC RECOURSE DEBT: EX. 2 X contributes $10 while Y and Z each contribute $100 to the XYZ general partnership. Each partner has a one-third share of profits and losses. The partnership borrows $60 on a fully recourse basis. A zero- value sale and liquidation yields a negative capital account only for X, and so X is allocated all of the debt. The books become: XYZ CAOBCAOBCAOB 10 100 6000 1070100

Slide 9

DYNAMIC RECOURSE DEBT: EX. 2 Suppose the partnership now distributes $70 to X. That reduces the partnerships cash down to $200, and a zero-value sale and liquidation will leave only X with a capital account deficit. Accordingly, all of the debt remains with X and the books of the venture become: XYZ CAOBCAOBCAOB 1070100 -70 0000 -600100

Slide 10

DYNAMIC RECOURSE DEBT: EX. 2 Now suppose that the partnership distributes $80 to Y. That reduces the partnerships cash down to $120. Prior to any reallocation of the debt, the books become: XYZ CAOBCAOBCAOB -600100 00-80 00 -60020 100

Slide 11

DYNAMIC RECOURSE DEBT: EX. 2 Now lets do a zero-value sale and liquidation. The partnership has $120 of cash, and assuming that falls in value to zero, each partner is allocated $40 of the loss. After the zero-value sale, the books of the venture become: XYZ CAOBCAOBCAOB -607020 100 -40 -100-2060

Slide 12

DYNAMIC RECOURSE DEBT: EX. 2 Because the debt is now allocated 5/6s to X and 1/6 to Y, one-sixth of the debt (that is, $10 of the debt) is shifted to Y. But because Xs outside basis is already zero, that means the cash distribution to Y triggers gain recognition to X. XYZ CAOBCAOBCAOB -60020 100 (10)100 -6002030100

Slide 13

NONRECOURSE DEBT: DEPRECIATION AND BOOK-UPS X contributes $1,000,000 and Y contributes Blackacre to XY-LLC, and Blackacre is worth $1,000,000 with an adjusted basis of $200,000 at the time of contribution. The partnership borrows $2,000,000 and uses its cash of $3,000,000 to improve Blackacre. These improvements can be recovered straight-line over 25 years, and the debt encumbers Blackacre as well as the improvements. On these figures, the property has an initial book value of $4,000,000, an adjusted basis of $3,200,000, and a depreciable basis of $3,000,000. There is depreciation of $120,000 per year for 25 years.

Slide 14

NONRECOURSE DEBT: DEPRECIATION AND BOOK-UPS YearBook ValueAdj. BasisDep. BasisDebt 04,000,0003,200,0003,000,0002,000,000 162,080,0001,280,0001,080,0002,000,000 171,960,0001,160,000960,0002,000,000 201,600,000800,000600,0002,000,000 YearTier 1Tier 2Tier 3Total 0002,000,000 160720,0001,280,0002,000,000 1740,000800,0001,160,0002,000,000 20400,000800,000 2,000,000

Slide 15

RELATED PARTY DEBT RULES New related party debt rules were proposed on December 16, 1013, as Prop. Reg. 1.752-4(b). The following discussion is based on these proposed regulations.

Slide 16

RELATED PARTY DEBT RULES Loan from Z to XY P YXZ XY

Slide 17

RELATED PARTY DEBT RULES Loan from Z to XY P YXZ XY Guarantee

Slide 18

RELATED PARTY DEBT RULES Loan from Z to XY P YXZ XY Partial Guarantee

Slide 19

PARTIAL SALE If a partner owning a single partnership interest sells a portion of that interest, gain is computed by comparing the amount realized on the sale with a proportionate part of the outside basis. The same rule applies if the partner owns multiple interests in the venture and sells only a part of his ownership interest without regard to how the interests were acquired (no tracing of basis). A partner has a single, unified outside basis. A partner has a single, unified capital account. After the sale, the capital account of the selling partner that is attributable to the interest transferred carries over to the transferee.

Slide 20

PARTIAL SALE EXAMPLE T joins the P partnership by contributing cash of $5,000 in exchange for a general partnership interest. Sometime later, T acquires a limited partnership interest for $7,000. Thereafter, when Ts combined outside basis in the two interests is $12,000, T sells one of the interests for its fair market value of $5,000. At the time of the sale, the two interests are worth $15,000. T recognizes a gain of $1,000 on the sale (amount realized of $5,000 less $4,000 allocable portion of adjusted basis). Note that it does not matter which interest is sold or whether that particular interest has increased or decreased in value (no tracing).

Slide 21

PARTIAL SALE: REV. RUL. 84-53 If a partner sells a portion of his partnership interest and the selling partner has been allocated a share of the partnerships liabilities, those liabilities not shifting as a result of the sale are removed from the selling partners outside basis immediately prior to the sale for the purpose of computing gain or loss on the sale. Suppose X and Y each own half of the XY partnership, and XY owns Blackacre with inside basis of $400, value of $500, and subject to a debt of $380. Each partner has an outside basis of $200 including each partners $190 share of the debt. Suppose Y sells one-half of her partnership interest to Z for its fair market value of $30.

Slide 22

REV. RUL. 84-53 EXAMPLE If half of Ys share of the debt shifts to Z, then gain on the sale equals amount realized of $125 (cash received plus debt shifted) less allocable portion of adjusted basis of $100, for a gain of $25. If no part of the debt shifts, then gain on the sale equals amount realized of $30 (cash received) less allocable portion of outside basis with debt removed (that is, one-half of ($200 - $190)) of $5, for a gain of $25.

Slide 23

SALE AFTER DEFT-FINANCED DISTRIBUTION X and Y own 60% and 40% of the profits and losses of XY-LLC. The partnership owns a single, nondepreciable asset with inside basis and book value of $0 but current value of $2,000. Each partner has a capital account and outside basis of $0. The partnership has an election under section 754 in effect and the partnership agreement provides that partnership assets will be booked to fair market value whenever allowable. The partnership borrows $500 on a recourse basis, allocable 60% to X and 40% to Y. The loan proceeds are then distributed in those percentages. Y sells half of her interest to Z for its value of $300.

Slide 24

SALE AFTER DEFT-FINANCED DISTRIBUTION XYZ CAOBCAOBCAOB 000000 0300020000 12000800000 -300 -200 00 00-3000300 90003000

Slide 25

SALE AFTER DEBT-FINANCED DISTRIBUTION: SALE OF PROPERTY XYZ COBCAOBCAOB 90003000 0120004000 00000-400 0-3000-20000 900 300200300