LLCs and the sec. 465 at-risk rules with DROs.

• Author: Packard, Pamela
• Position: Deficit restoration obligations

Does a limited liability company (LLC) operating agreement, with a deficit restoration obligation (DRO) enforceable under state law, increase members' amounts considered at-risk? Under Sec. 465, a taxpayer's deductible loss is generally limited to the amount at-risk; for any given activity, this includes cash contributions, adjusted basis of property contributed to the activity and amounts borrowed as to it. Under Sec. 465, the taxpayer includes the amounts borrowed in determining at-risk basis to the extent he or she is personally liable for repayment or has pledged assets not used in the activity as security for them.

For example, an LLC secured a bank debt; the security agreement provided that in addition to specific equipment, general intangibles and funds arising out of the LLC's activities or related to it are collateral. For purposes of the loan agreement, the LLC operating agreement would contain a DRO enforceable under state law. As a result, creditors could force a member to repay the debt from individual assets, through a garnishment proceeding.

Field Service Advice (FSA) 1999-993 involved an analogous situation. It concluded:

[i]n the case of a limited partner, the litmus test for inclusion of debt in their amount at risk is the extent to which the limited partner bears ultimate personal liability for amounts borrowed by the partnership ... [citing Callahan, 98 TC 276 (1992)]. In Pritchett ... 85 T.C. 581 (1985), rev'd and remanded 827 E2d 644 (9th Cir. 1987), a limited partnership executed a recourse note in connection with a turnkey drilling arrangement. Only the general partners were personally liable under the note. However, the limited partnership agreement provided that in the event the note was not paid in full at maturity, the limited partners would be personally obligated, if called upon by the general partners, to make additional capital contributions to the...