Allocation of Partnership Debt

• Pages: 153-172
• Author: James R. Repetti,William H. Lyons,Charlene D. Luke

153

Chapter Eight

ALLOCATION OF PARTNERSHIP DEBT

A. Introduction

As discussed in Chapter 3 § B, partners include their shares of

partnership debt in their outside bases because § 752(a) treats

increases in a partner’s share of partnership debt as cash

contributions by the partner to the partnership. Section § 752(b)

treats decreases in a partner’s share of partnership debt as cash

distributions to that partner. These rules are important because

§ 704(d) limits a partner’s deductions to the amount of that partner’s

outside basis.

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In addition, cash distributions to a partner will result

in gain reco gnition to the extent such distributions exceed the

partner’s outside basis.

2

This Chapter discusses the rules that determine eac h partner’s

share of partnership debt under the § 752 regulations. The threshold

issue is whether the partnership’s debt is the type of liability that the

regulations include in the partner’s outside basis. (A partner’s capital

account is not affe cted by changes in the partner’s share o f

partnership liabilities.

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) After that issue is resolve d, it is next

necessary to classify the debt a s recourse or no nrecourse. The

regulations contain very different rules for allocating debt depending

on whether it is recourse or nonrecourse.

B. What Is a Partnership Liability Under § 752?

Prior to 2005 amendments, the § 752 regulations provided little

guidance on the question of the type of partnership d ebt that would

qualify as a “liability” for purposes of § 752. The current regulations,

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however, provide that an obligation will qualify as a “liability” for

purposes of § 752 only if (1) it creates or increases the partnership’s

basis in its assets (including cash), (2) it results in an immediate

deduction when incurred, or (3) it is attributable to a cost that is not

deductible and does no t qualify as a capital expenditure.

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This

treatment comes from Revenue Ruling 88–77,

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which notes that

under this approach an obligation that will result in a d eduction

when paid (rather than when incurred) will not qualify as a “liability”

1

See Chapter 3 § C.1.

2

See Chapter 3 § B and Chapter 11 § B.

3

Reg. § 1.701–1(b)(2)(iv)(c).

4

Reg. §§ 1.752–1, –2, –3, and –7.

5

Reg. § 1.752–1(a)(4)(i).

6

1988–2 C.B. 128.

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Allocation of Partnership Debt

Ch. 8

for § 752 purposes. The need for this treatme nt stems mainly from

problems that occur in transferring accounts payable of a cash-

method taxpayer to a partnership, a matter that will be examined in

greater detail in § F below.

Example 8-1: The YZ partne rship employs the cash

method of accounting and incurs the following obligations:

(1) It borrows $10,0 00 cash from a bank.

(2) It purchases a used truck, giving the seller a note

for $4,000 and taking the truck with a $4,000 tax

basis.

(3) It promises to contribute $5,000 to a political

candidate. Political contributions are not

deductible. § 162(e).

(4) It owes an employee $800 for services performed

last week.

Obligations 1 and 2 qualify as partnership “liabilities”

to be allocated to partners under § 752 because the

partnership obtained a tax basis in cash and in the truck as

a result of the loans.

Obligation 3 also qualifies as a partnership “liability”

for purposes of § 752 because it is a nondeductible cost that

is not a capital expenditure.

Obligation 4 does not qualify as a partne rship

“liability” because it did not result in a deduction when

incurred but instead will be deductible when paid.

Suppose that YZ uses the accrual method of accounting

instead of the cash method. In th at situation, assuming all

the requirements for accrual have been met,

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Obligation 4

would qualify as a “liability” because the incurrence of the

obligation to pay the s alary results in an imm ediately

deductible cost.

C. The Definition of Recourse and Nonrecourse

Debt

1. Introduction

Because the § 752 regulations adopt different rules for

allocating partnership liabilities based on the debt’s type, it is

important to determine whether the debt is recourse or nonrecourse.

Before focusing on the approach of the § 752 regulations, it is helpful

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See, e.g., § 461(h) (economic performance requirement for accrual-method

deductions).