Prop. regs. on partnership's assumption of partner's liabilities.

• Author: Carpenter, Timothy P.

In June 2003, Treasury issued two sets of regulations (TD 9062, REG-106736-00) on a partnership's assumption of a partners liabilities--Temp. Kegs. Sec. 1.752-6T and Prop. Regs. Sec. 1.752-7. The regulations were issued in response to the enactment of Sec. 358(h) by Section 1(a)(7) of the Community Renewal Tax Relief Act of 2000 (2000 Act), and are intended to prevent the duplication and acceleration of losses through a partnership's assumption of a partner's liabilities.

As is explained below, the temporary regulations apply retroactively to assumptions of fixed and contingent liabilities (as broadly defined in Sec. 358(h)(3)) occurring after Oct. 18, 1999 and before June 24, 2003. The proposed regulations include an expansive definition of the term "liability," as well as complex rules on the deduction that occurs on economic performance as to the liability; the proposed rules generally would apply to liability transfers occurring after June 23, 2003. However, a taxpayer can elect to apply them retroactively to liability transfers occurring after Oct. 18, 1999. The election must be made on the first timely filed partnership income tax return filed after Sept. 23, 2003; thus, in certain cases, a tax adviser will need to promptly consider whether to elect to apply the proposed rules retroactively.

Overall, the regulations (particularly the proposed ones) are extremely complex. Careful analysis of their potential tax consequences is needed to assess properly the advantages and/or disadvantages of electing to apply the proposed regulations retroactively.

Background

Congress included Sec. 358(h) in the 2000 Act to thwart certain loss-duplication transactions. It was primarily concerned with a transfer of property to a corporation in exchange for stock and the corporation's assumption of certain of" the transferor's contingent obligations. The transferor would assert that the corporation's assumption of the obligations reduced the fair market value (FMV)--but not the basis--of the stock received in the exchange, then later sell all or a portion of the stock and claim a loss.

In response, Congress enacted Sec. 358(h), on the assumption of liabilities in corporate nonrecognition exchanges. Sec. 358(d) generally provides that a transferor has to treat certain liabilities assumed in an exchange as money received; however, for this purpose, "liability" does not include one excluded under Sec. 357(c)(3). In turn, Sec. 357(c)(3) refers to liabilities the payment of which either (1) would give rise to a deduction or (2) would be described in Sec. 736(a) (guaranteed payments), provided that such liabilities did not result in the creation of, or an increase in, the basis of property.

Generally, Sec. 358(h)(1) provides that, if the basis of stock received in a nonrecognition exchange exceeds its FMV (after applying the Sec. 358 provisions discussed above), the basis must be reduced (not below FMV) by any liability assumed in such exchange. However, there are some exceptions. Sec. 358(h)(2) generally provides that Sec. 358(h)(1) does not apply to any liability if (1) the trade or business with which the liability is associated is transferred to the person assuming the liability as part of the exchange or (2) substantially all the assets with which the liability is associated are transferred in the exchange. For Sec. 358(h) purposes, Sec. 358(h)(3) defines "liability" to include any fixed or contingent...