Allocation of partnership liabilities.

• Author: Mason, Donald J.

Although the Final Sec. 752 Regulations Have Been Streamlined, They Require a Complex Analysis of Related Rules and State Law Sec. 752 provides the mechanism under which a partner may include his share of partnership liabilities in computing his tax basis in his partnership interest. Partnership basis is important in determining a partner's limitation on the deduction of losses as well as on the amount of money that can be received through a partnership distribution without gain recognition under Sec. 731.

The general statutory rules of Sec. 752(a) and (b) can be divided into a share rule and an assumption rule. Under the share rule, (1) any increase in a partner's share of partnership liabilities is considered to be a contribution of money to the partnership by the partner, and (2) any decrease in a partner's share of partnership liabilities is considered to be a distribution of money to the partner by the partnership. The assumption rule likewise has two mirror components: (1)The assumption of a partnership liability by a partner is deemed to be a contribution of cash by the partner, and (2) the assumption of a partner's liability by the partnership is deemed to be a cash distribution to the partner. The statute does not address the rules for determining a partner's share of partnership liabilities. These rules are left to the regulations.

On Dec. 20, 1991, the IRS issued final regulations under Sec. 752 dealing with the allocation of partnership liabilities. With the issuance of these final regulations, partnerships are potentially subject to three different sets of liability sharing rules: (1) the "old" regulations (Regs. Sec. 1.752-1(e),2 as amended); (2) the "temporary" regulations (Temp. Regs. Sees. 1.752-0T through -4T,3 as amended); and (3)the "final" regulations (Regs. Sees. 1.752-0 through 1.752-5).

Effective Dates

In general, the Sec. 752 regulations are effective based on the date that the liability is incurred, unless there is a material modification of the liability or the partnership elects to apply a subsequent version of the regulations. Assuming that no material modification of the liability occurs and that no election to apply a different set of regulations is made, the general effective date rules are as follows.

The final regulations generally apply to liabilities incurred or assumed by the partnership on or after Dec. 28, 1991 (subject to a fairly standard binding contract exceptional? The temporary regulations generally apply to liabilities incurred or assumed by the partnership on or after Jan. 30, 1989 and before Dec. 29, 1991, except for certain "direct" partner loans and guarantees, which are subject to the temporary regulations as of the later of Mar. 1, 1984 or the date of the loan or guarantee subject to a fairly standard binding contract exception).5 The old regulations govern allocations of liabilities incurred or assumed by the partnership prior to the effective dates of the temporary regulations.6

A nonrecourse liability incurred or assumed by a partnership prior to Mar. 1, 1984 is subject to the old regulations. A subsequent guarantee by a partner or a related person does not change this result. Thus, such nonrecourse liabilities are to be allocated in accordance with partnership "profits," The generally accepted theory for allocating nonrecourse liabilities in accordance with profits is that the nonrecourse debt will be paid off with partnership profits, or the income will be allocated in accordance with profits interests if the nonrecourse debt is forgiven or if the property is sold. The determination of a partner's interest in profits, however, is often uncertain in complex partnership agreements involving special allocations of various items of income, gain, etc.

A third-party nonrecourse liability incurred or assumed by a partnership before Jan. 30, 1989 is governed by the old regulations. The liability is treated as a nonrecourse liability subject to the old regulations even if the liability is subsequently guaranteed by a related person. Thus, the same uncertainty in determining a partner's interest in profits exists. If the liability was incurred or assumed by the partnership after Feb. 29, 1984 and before Jan. 30, 1989, a partner guarantee of the liability would subject the liability to the temporary regulations.

* Elections

A partnership may elect to apply the final regulations to all of its liabilities as of the beginning of the first tax year of the partnership ending on or after Dec. -28, 1991.7 Regs. Sec. 1.752-5(b)(2) provides that the election is made by attaching a written statement (containing certain specified information) to the partnership return for the first tax year ending on or after Dec. 28, 1991. A second election exists under Temp. Regs. Sec. 1.7524T(d)(3), which allows a partnership to apply the temporary regulations to previously incurred liabilities by filing an amended return for the first tax year of the partnership ending after Dec. 9.9, 1988. For its first tax year ending after Dec. 9.7, 1991, a partnership is also permitted to elect to apply the temporary regulations to liabilities incurred or assumed by the partnership after Dec. 27, 1991 and before Jan. 1, 1992.8 These elections allow the partnership to simplify its tax records that track liabilities incurred in transitional years, as well as attempt to take advantage of liability allocation methods prescribed by later issued regulations. Any election should be carefully evaluated under both the Sec. 704(b)and Sec. 752 regulations. In addition, an election to apply the temporary or final regulations may provide an opportunity for a partnership with special allocations to determine liability allocations with greater certainty than existed under the old regulations.

* Terminations and admissions

A partnership termination under Sec. 708(b)(1)(B) will not change the general effective date rules, i.e., the newly constituted partnership will not be treated as incurring or assuming partnership liabilities on the termination date.9 Although not specifically stated in the regulations, the admission of new partners...