IRS Attacks Leveraged Partnerships
New IRS Regulations Restrict Taxpayers Ability to Structure Leveraged Partnership Deals and Change the Allocation of Debt Rule
Recently, the Treasury Department and the Internal Revenue Service (“IRS”) issued highly anticipated Final, Temporary and Proposed Treasury Regulations (collectively the “New Regulations”) addressing “disguised sales” of property involving partnerships and allocations of partnership liabilities among partners.
As of January 3, 2017, when a taxpayer contributes property to a partnership, the Temporary Regulations treat all partnership liabilities (with limited exceptions) as non-recourse, even if the taxpayer is personally liable on some or all of the debt. This will effectively eliminate most leveraged partnership transactions for taxpayers contributing property where the tax basis is less than the related liabilities. The new rules will particularly affect many UPREIT deals where taxpayers contribute their properties for partnership units, convertible into the stock of the public REIT that owns the partnership.
“Bottom dollar” guarantees are no longer respected. The Temporary Regulations change the way partnership liabilities are allocated among the partners. Debt will be allocated to a partner based on his personal guarantee only if he is liable in a first loss position, rather than a last loss position. Previously, a partner could guarantee the “bottom” of the loan and a commensurate amount of debt would be allocated to him. This enabled the partner to avoid triggering his negative capital account without assuming significant liability for the debt. Now the partner, who intends to use a guarantee of partnership debt so that sufficient debt will be allocated to him, must guarantee the entire debt or at least a “vertical slice” from dollar one. In addition, the Proposed Regulations add an anti-abuse rule for purposes of determining when a partner’s guarantee of a partnership liability would be treated as recourse to the partner.
The Final Regulations clarify certain exceptions to the disguised sale rules such as reimbursement of “pre-formation expenditures” and contributions of “qualified liabilities.” No longer will a partner be entitled to receive tax-free reimbursement of his recent capital expenditures on contributed property when the expenditures were financed by debt assumed by the transferee partnership. Also, the “preformation expenditure” exception is now applied on a property-byproperty basis.
Senior Managing Director
Senior Managing Director