In recent months, the IRS and the Department of the Treasury have issued a number of final, temporary and proposed regulations impacting persons who own interests in entities taxed as partnerships. On October 5, 2016, the IRS and the Department of the Treasury published final, temporary, and proposed regulations that make a number of significant changes to rules under IRC Sections 707 and 752 applying to “disguised sales” of property from a partner to a partnership and allocations of partnership liabilities among partners. Two of the more important changes are highlighted below.
In general, a transfer of property by a partner to a partnership followed by a transfer of money or other consideration from the partnership to the partner will be treated as a “disguised sale” of property by the partner to the partnership, subject to rules and exceptions provided in the regulations. Among the most important changes to the “disguised sale” rules are new temporary regulations that require the allocation of partnership liabilities among the partners in a manner generally intended to maximize a partner’s disguised sale gains. For purposes of the disguised sale rules, all liabilities of a partnership (whether they are recourse or nonrecourse) are generally treated as nonrecourse liabilities and must be allocated to the partners solely in accordance with the partners’ allocable share of partnership profits. This rule is effective for any transaction with respect to which all transfers occur on or after January 3, 2017. The rule will impact, among other things, the “debt-financed distribution” exception, which generally provides that distribution of cash to a partner in connection with a property contribution by such partner is not treated as a taxable sale to the extent that the cash is traceable to a partnership liability (incurred within 90 days of the distribution), and the amount of the distribution does not exceed the partner’s allocable share of the liability incurred to fund the distribution. As a result of the new temporary regulations, a partner’s guarantee or other payment obligation will no longer be taken into account in determining whether a debt-financed distribution to a partner exceeds the partner’s allocable share of the liability. Accordingly, any disproportionate leveraged distribution may trigger gain to the extent the liability is incurred in connection with a property contribution to, or distribution from, a partnership.
Temporary regulations issued under Section 752, which are based on proposed regulations issued in 2014, also provide guidance that disregards any “bottom dollar payment obligation” of a partner in determining whether the partner bears the economic risk of loss for a partnership liability, subject to certain exceptions. In general, a bottom dollar payment obligation is a guarantee of a partnership liability that applies to less than the full amount of the liability. This portion of the temporary regulations generally applies to partnership liabilities incurred, assumed or guaranteed on or after October 5, 2016, subject to a limited seven-year grandfather rule and to a binding contract exception.