Allocation of nonrecourse debt under the three-tier sec. 752 allocation process.

• Author: Ellentuck, Albert B.

Facts: Lois and Clark are forming The Daily Planner Partnership, which they will own equally. Lois contributes $40,000 cash and Clark contributes depreciable property with a $40,000 tax basis and a $100,000 fair market value (FMV). The property is burdened with a $60,000 nonrecourse liability. * The partnership agreement provides for 50/50 allocations of all partnership items of income, gain, deduction and loss. In addition, the partnership maintains capital accounts in accordance with the Sec. 704(b) safe harbor rules. * Both partners are concerned they will not receive their fair share of basis allocated to them from the $60,000 nonrecourse note and have asked the partnership's tax adviser to provide them with a detailed calculation showing how the nonrecourse note will be allocated between them. Issue: How will the $60,000 basis from the nonrecourse liability be allocated between Lois and Clark under the three-tier Sec. 752 allocation process?

Analysis

To provide for appropriate matching of basis with nonrecourse deduction allocations and with distributions related to nonrecourse liabilities and to prevent inappropriate shifts in the sharing of such liabilities, Regs. Sec. 1.752-3 provides that a partner's share of partnership nonrecourse liabilities equals:

1. the partner's share of partnership "minimum gain" under the Sec. 704(b) regulations, plus

2. the partner's share of any taxable gain allocated to that partner under Sec. 704(c) (or in the same manner of Sec. 704(c) book/tax differences), plus

3. the partner's share of "excess" nonrecourse liabilities.

Tier-One Allocations

A partner's share of minimum gain generally is determined in accordance with the Sec. 704(b) safe harbor regulations that govern the allocation of partnership losses and deductions attributable to nonrecourse liabilities. Under these rules, minimum gain is defined as the sum of the hypothetical gains a partnership would recognize if, in a taxable transaction, it disposed of all partnership assets that secure nonrecourse liabilities in full satisfaction of those liabilities and for no other consideration. The assets' book value, not the adjusted tax basis, is used when calculating minimum gain.

In this case, there is no partnership minimum gain, since the property's "book" basis ($100,000) exceeds the nonrecourse debt ($60,000). Therefore, there is no tier-one Sec. 752 allocation to be made.

Tier-Two Allocations

A partner's share of Sec. 704(c) minimum gain, the...