At-risk rules - Sec. 465 prop. regs.

• Author: Kozenko, Elizabeth
• Position: Deductions in excess of basis resulting in taxable gains

Calculating a partner's at-risk amount can be complicated when applying certain financing rules. An incorrect determination could mean missed deductions or deductions in excess of basis, resulting in taxable gains. To avoid this, tax advisers should pay close attention to calculating these amounts. Generally, when a partner becomes ultimately liable for debt related to an at-risk activity, his or her at-risk basis increases. The proposed regulations under Sec. 465 offer further analysis.

Inconsistencies

Prop. Kegs. Sec. 1.465-7(a) allows for an increase in at-risk basis for a partner's loan to a partnership. Conversely, Prop. Kegs. Sec. 1.465-6(d) does not permit an increase in at-risk basis for a guarantee of partnership nonrecourse debt. However, the increase in at-risk basis is permitted when the partner is required to make payment on the debt. This treatment is inconsistent with the more lenient rules in Kegs. Sec. 1.752-2(d) (2), which allow guarantees of nonrecourse debt to increase at-risk basis. The inconsistency is currently unresolved. To be protected trader both regulations, practitioners should follow the tests outlined in Abramson, 86 TC 360 (1986), Gefen, 87 TC 1471 (1986), and Bennion, 88 TC 684 (1987), which allowed for an increase in at-risk basis for guarantees:

1. That were absolute and unconditional.

2. For which there was no right of subrogation, contribution or reimbursement from the entity or other owner.

3. For which the guarantor bore ultimate responsibility for the debt (or a portion thereof), if the entity defaulted.

Partners are not at risk to the extent they are protected against losses. For example, Prop. Kegs. Sec. 1.465-6 looks through to the ultimate legal rights to determine whether at-risk basis should be disallowed. If a partner has the legal right to sue other partners for reimbursement or is entitled to a contribution from them, the partner will not be at risk. Prop. Kegs. Sec. 1.465-6(e) provides an example.

Example (1). A, an individual, borrows $6,000 from a bank for use in an activity described in Sec. 465(c)(1).A is not personally liable for repayment of the loan but, rather, pledges as security, assets not used in the activity with a $6,000 net fair market value (FMV). However, a third party, B, guarantees A that A's entire loss from the activity will be repaid to A by B. Because A is protected against loss on the loan, A's at-risk amount is not increased as a result of the entire transaction.

The...