Transfers of encumbered property to a partnership by more than one partner.

• Author: Ellentuck, Albert B.

Facts: In January 1996, the Whitewater Partnership, a real estate development operation, approached Bill and Hillary about two pieces of real estate they owned. In exchange for the property, Bill and Hillary would receive limited partnership interests in Whitewater. Pursuant to an integrated plan, the transfers were scheduled to take place in February 1996, at which time both Bill and Hillary would each become one-third limited partners in Whitewater. At that time, Bill's property, Property 1, had a fair market value (FMV) of $100,000, an adjusted tax basis of $60,000, and a $60,000 nonrecourse liability. This note was obtained by Bill in January 1996 to pay off his personal credit cards. Property 2, owned by Hillary, had an FMV of $100,000 and an adjusted basis of $40,000. Hillary had obtained a $70,000 recourse note in January 1996 that was secured by Property 2. She used the proceeds to redecorate her home. * Pursuant to the plan, the partnership takes Bill's property subject to liability I and assumes liability 2 as part of the transaction. Bill has additional capital contribution requirements of $35,000. issues: Will Bill or Hillary recognize any gain due to the assumption of the liabilities? What effect does the netting of the liabilities have to each of them?

Analysis

In general, a partnership's assumption of a partner's liability is equivalent to a withdrawal from the partner's interest in that partnership. When a portion of a partner's liability is shifted in connection with the transfer of property to the partnership, a disguised sale is deemed to have taken place. The liability assumed by the partnership exceeding the portion allocated to the partner immediately after the assumption is treated as a disguised sale.

If the transfer of property by a partner to a partnership is not otherwise treated as part of a sale, the partnership's assumption of a "qualified" liability in connection with a transfer of property is not treated as part of a sale. The definition of qualified liabilities includes debt incurred more than two years before the transfer (or written agreement to transfer); debt incurred within two years of the transfer (or written agreement to transfer) that was not in anticipation of the transfer (this type is highly subject to challenge unless it can be clearly shown by the facts and circumstances that it was not in anticipation of the transfer); acquisition or improvement indebtedness; and liabilities incurred in the...