Violating certain 'bad boy' guarantees can trigger recourse liabilities.

• Author: Allen-Anthony, Sarah E.

The bad-boy guarantee is a typical arrangement in real estate loans. When a borrower takes a nonrecourse loan to purchase real estate, the lender can foreclose only on the real estate; it cannot go after the borrower. To reduce risk for the lender, these arrangements often contain a bad-boy guarantee.

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The bad-boy guarantee is a promise by the borrower not to violate certain conditions, such as fraud and items related to bankruptcy. If the bad-boy guarantee is violated, the lender can go after the guarantor, meaning the loan becomes recourse. The question remains, however, whether a bad-boy guarantee changes the otherwise nonrecourse liability (shared by all partners) to a recourse liability (allocated to only the guarantor).

Sec. 752(a) provides that any increase in a partner's share of the liabilities of a partnership is considered a contribution of money by the partner to the partnership. Regs. Sec. 1.752-2 provides that a partnership liability is a recourse liability to the extent that any partner bears the economic risk of loss for that liability.

Under Sec. 465(b)(6), notwithstanding any other provision of the Internal Revenue Code or regulations, a taxpayer engaged in the activity of holding real property is considered at risk with respect to the taxpayer's share of any qualified nonrecourse financing that is secured by real property used in the activity. Qualified nonrecourse financing means any financing that is not convertible debt that is borrowed from a qualified person or federal, state, or local government or instrumentality, or is guaranteed by any federal, state, or local government with respect to the activity of holding real property and with respect to which no person is personally liable for repayment.

CCA 201606027

IRS Chief Counsel Advice (CCA) 201606027, released Feb. 5,2016, concluded that a bad-boy guarantee could cause a nonrecourse real estate loan to be treated as recourse.

In the CCA, a managing member of a real estate partnership made bad-boy guarantees to a third-party lender when obtaining financing for property renovations and operations. In the CCA, the IRS determined that this guarantee was sufficient to treat the debt as a recourse liability for the managing member even though no events had occurred to trigger the guarantee. Because the debt was treated as a recourse liability of the managing member, the partnership's losses were allocated to the managing member, and none were...