IRS rules govern disguised sales and allocations of partnership liabilities.

AuthorNevius, Alistair M.

On Oct. 4, the IRS issued final, temporary, and proposed regulations providing guidance on partnership disguised sales and allocation of liabilities.

The final regulations (T.D. 9787) address disguised sales of property by or to a partnership and allocations of excess nonrecourse liabilities to partners, which may be disguised sales.

The temporary and proposed regulations (T.D. 9788 and REG-122855-15) cover allocations of liabilities and recognition of obligations when determining if a liability is a recourse partnership liability under Sec. 752.

T.D. 9787 finalizes proposed regulations that were issued in 2014 (REG-119305-11), with some changes in response to comments. In response to a comment that the IRS's guidance regarding a partner's share of partnership liabilities should apply only for disguised-sale purposes, the IRS has reconsidered the rules in Prop. Regs. Sec. 1.707-5(a)(2) and, instead of finalizing that section, has issued temporary and proposed regulations that cover that issue.

Disguised Sales

Sec. 707 is intended to prevent partners from recharacterizing a sale or exchange of property as a contribution to the partnership followed by a distribution by the partnership, which could avoid or defer tax on the transaction.

There are several exceptions to this disguised-sale rule, including the debt-financed-distribution exception, which provides an exception for a distribution to the extent it is traceable to a partnership borrowing that is allocable to the partner. Other exceptions from disguised-sale treatment are found in Regs. Sec. 1.707-4, which, among other things, excludes from disguised-sale treatment payments that qualify as reasonable guaranteed payments to a partner. The regulations introduce an ordering rule for determining which payments may be excluded from disguised-sale treatment by providing that the debt-financed exemption applies first, with any remaining amounts tested under Regs. Sec. 1.707-4.

Another change in the rules is to the treatment of preformation capital expenditures under Regs. Sec. 1.707-4(d), which is amended to address three issues. First, the regulations provide how the exception for preformation capital expenditures applies in the case of multiple property transfers. In addition, the rules clarify the definition of "capital expenditures" for purposes of this exception. The regulations also provide a rule coordinating the exception for preformation capital expenditures and the rules regarding...

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