Final regs. on treatment of disregarded entities under Sec. 752.

• Author: Hortenstine, Barksdale

Treasury and the Service issued final regulations (TD 9289, 10/11/06) under Sec. 752, on taking into account certain obligations of a business entity disregarded as separate from its owner under Sec. 856(i) (a qualified real estate investment trust subsidiary), Sec. 1361(b)(3) (a qualified subchapter S subsidiary) or the check-the-box rules (collectively, a disregarded entity). The rules help determine the extent to which a partner is deemed to bear the economic risk of loss for a partnership liability when it holds a partnership interest through a disregarded entity.

The regulations are generally effective for liabilities incurred or assumed by a partnership after Oct. 10, 2006.

Background

Sec. 752 provides that a partner's basis in its partnership interest includes its share of partnership liabilities. In general, a partner is allocated a share of a partnership liability under Sec. 752 to the extent it bears the "economic risk of loss" for repayment.

Treasury and the Service had issued proposed regulations (REG-128767-04, 8/12/04) under Sec. 752 for taking into account certain obligations of disregarded entities. The final rules adopted the proposed regulations in substantially the same form.

Final Regs.

Net value approach: The proposed regulations provide that a disregarded entity's payment obligation for which a partner is treated as bearing the economic risk of loss is taken into account only to the extent of the disregarded entity's net value. Some commentators disagreed with this approach, arguing that it would result in the inconsistent treatment of similar economic situations and unwarranted complexity. Treasury and the Service, however, believe that applying the presumption of deemed satisfaction to a disregarded entity that shields a Federal tax partner from liability for the entity's obligation would, in many cases, cause partnership liabilities economically indistinguishable from nonrecourse liabilities to be classified as recourse under Sec. 752. Thus, the final regulations retain the proposed regulations' rule.

Not extended to other entities: Treasury and the IRS requested comments on whether the proposed regulations should extend to the Regs. Sec. 1.752-2(b) (1) payment obligations of other entities (i.e., entities not disregarded, but nominally capitalized). Some commentators suggested that the Regs. Sec. 1.752-2(j) anti-abuse rule could be expanded to cover certain situations involving thinly capitalized entities. Although...