Partner Level Loss Limits Secs. 704(d), 465, and 469. Chapter 10

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1 Partner Level Loss Limits Secs. 704(d), 465, and 469 Chapter 10 CCA Taxpayer Friendly view of Reg (d) regarding guarantees of LLC debt

2 10-12 Under the "guarantee rule" of prop. reg. sec (d), a guarantee does NOT increase a taxpayer's atrisk amount until the taxpayer pays the guaranteed debt CCA states that this regulation is not applicable to guarantees of LLC debt and implies the same for limited partner guarantees where the Ltd. Ptr. Waives subrogation 10-14

3 10-12 Prop. reg. sec (a)(2) provides that when a partnership incurs a liability and the partners may be held personally liable under state law, a partner's amount at risk is increased to the extent the partner is not protected against loss. In CCM AM Another Taxpayer Friendly view of Reg (d) regarding guarantees of LLC debt

4 Issue 1 What are the tax consequences under the at-risk rules to an LLC member who guarantees debt of an LLC classified as a partnership or disregarded entity for federal tax purposes? Conclusion: An LLC member is at risk with respect to LLC debt guaranteed by such member without regard to whether the LLC member waives any right to subrogation, reimbursement, or indemnification against the LLC, but only to the extent that: (1) the guaranteeing member has no right of contribution or reimbursement from persons other than the LLC, (2) the guaranteeing member is not otherwise protected against loss within the meaning of IRC sec. 465(b)(4) with respect to the guaranteed amounts, and (3) the guarantee is bona fide and enforceable by creditors of the LLC under local law.

5 Issue 2: What are the tax consequences under the at-risk rules to an LLC member who guarantees debt that is qualified nonrecourse financing? Conclusion: Because the guarantor is personally liable for that debt, the debt is no longer QNF. The at-risk amount of the LLC member that guarantees LLC debt is increased

6 Issue 3: What are the tax consequences under the at-risk rules to the other members when an LLC member guarantees debt that had been treated as qualified nonrecourse financing (QNF)? Conclusion: Because, the debt guaranteed by an LLC member is no longer QNF, the nonguaranteeing members of the LLC may no longer include that amount of the debt in determining their amount at risk (debt share drops to zero) Chief Counsel rejects the argument that prop. reg. sec (d) protects them.

7 Example In Year 1, A and B each contribute $50,000 to the formation of the AB LLC which is taxed as a partnership. The partners share profits and losses equally. AB LLC purchases residential real estate (to rent) for $1,000,000 paying $100,000 down and financing the balance with a bank loan of $900,000 secured by the real estate thus the debt is qualified nonrecourse financing (QNF). The bank has recourse against LLC assets, but because neither partner guarantees the debt, the bank does not have recourse against any member of the LLC (due to state law protection of LLC members) and thus the debt is nonrecourse debt under IRC sec. 752 and also qualified nonrecourse financing (QNF).

8 The QNF is shared by the partner/members equally, $450,000 each, pursuant to IRC sec. 752, so each partner s beginning outside basis is $500,000 ($50,000 capital + $450,000 debt). Each partner is at-risk on the debt because it is QNF. Over the next 10 years, the partnership generates total depreciation of <$300,000> which matches the total net losses. All other items of income and deduction net to zero. No debt principal is repaid. Assume that, although the losses are passive under IRC sec. 469, each member/partner had sufficient passive income from other sources to deduct the passive losses each year.

9 End of Year 10 (before considering A s guarantee of the LLC debt), the partnership s tax basis balance sheet is: $ 700,000 of real prop. ($1 mi. - $300,000) $ 900,000 of debt <$200,000> of equity (<$100,000> per partner) Each partners outside basis and at-risk is $350,000 ($500,000 - $150,000 losses) At the end of Year 10, member/partner A guarantees the debt of $900,000. The debt ceases to be QNF. The debt is now recourse debt because the lender has recourse against a member/partner of the LLC. A s outside basis increases to $800,000 ($350,000 + $450,000).

10 Partner B recognizes $100,000 or gain under IRC sec. 731(a)(1) ($450,000 deemed cash distribution minus $350,000 pre-distribution outside basis). Comprehensive Examples

11 Example 10-21: Simple Example of Partnership Life Cycle Formation Alice and Bill form the AB calendar year Limited Partnership. Alice, the general partner, contributes $200,000 to AB. Bill, the limited partner, contributes $800,000 to AB. Assume that Alice and Bill both materially participate in the partnership business. The partnership agreement allocates profits and losses 20% to Alice and 80% to Bill. Liquidation proceeds are distributed in accordance with capital accounts. Operation All income and expenses are equal except for the $2,000,000 of gain in the transaction below. The partnership purchases land held for sale (ordinary asset) for $1,000,000. Subsequently, the land appreciates in value and is sold for $3,000,000 (ordinary income = $2,000,000). Alice is allocated $400,000 (20%) of ordinary income. Bill is allocated $1,600,000 (80%) of ordinary income. No operating distributions are made.

12 Liquidation: The partnership liquidates and terminates. Alice receives $600,000 in liquidation of her AB partnership interest, which is a tax free recovery her remaining outside basis (IRC sec. 731). Bill receives $2,400,000 in liquidation of his AB partnership interest, also a tax free recovery of his remaining outside basis. Alice and Bill s Tax (and Book) Basis Capital Accounts: A B Total Beginning $ 200,000 $ 800,000 $ 1,000,000 Income $ 400,000 $ 1,600,000 $ 2,000,000 Balance $ 600,000 $ 2,400,000 $ 3,000,000 Liquidating -$ 600,000 -$ 2,400,000 -$3,000,000 Distribution Ending $0 $0 $0

13 Alice and Bill s Outside Basis: A B Beginning $ 200,000 $ 800,000 Income $ 400,000 $ 1,600,000 Balance $ 600,000 $ 2,400,000 Liquid. -$ 600,000 -$ 2,400,000 Distribution Ending $0 $ Example 10-22: Outside Basis Includes Debt Formation Alice and Bill form the AB calendar year Limited Partnership. Alice, the general partner, contributes $200,000 to AB. Bill, the limited partner, contributes $800,000 the AB. Assume that both partners materially participate in the business. The partnership agreement allocates profits and losses 20% to Alice and 80% to Bill. Liquidation proceeds are distributed in accordance with capital accounts.

14 Operation All income and expenses are equal except for the $1 million of gain in the transaction below. The partnership borrows $1,000,000 from a bank (recourse debt) and purchases land held for sale for $2,000,000. The debt is secured by the land. The debt is allocated 100% to Alice, the general partner, as a result of her state law liability for partnership debts (IRC sec. 752). Alice bears the ultimate economic risk of loss for the debt (if all assets are worthless she must pay the debt). Applying the constructive liquidation test, if the assets are sold for zero, the resulting loss of $2,000,000 is allocated $1,200,000 to Alice and $800,000 to Bill. The hypothetical loss would leave Alice with a negative capital account of $1,000,000 (the exact amount of the debt). Subsequently, the land is sold for $3,000,000, producing ordinary income $1,000,000 ($3,000,000 sales price minus $2,000,000 adjusted basis) and $1,000,000 of debt is paid. Alice is allocated $200,000 (20%) of ordinary income. Bill is allocated $800,000 (80%) of ordinary income. Liquidation Following the land sale, the partnership has $2,000,000 of cash (the only asset). The partnership liquidates and terminates. AB distributes $400,000 to Alice in liquidation of her partnership interest (tax free basis recovery per IRC sec. 731). AB distributes $1,600,000 to Bill in liquidation of his partnership interest (tax free basis recovery).

15 Alice and Bill s Tax (and Book) Basis Capital Accounts: A B Total Contribution $ 200,000 $ 800,000 $ 1,000,000 Income $ 200,000 $ 800,000 $ 1,000,000 Balance $ 400,000 $ 1,600,000 $ 2,000,000 Liquidating -$ 400,000 -$ 1,600,000 -$ 2,000,000 Distribution Ending Bal. $0 $0 $0 Alice (GP) and Bill s (LP) Outside Basis: A B Contribution $ 200,000 $ 800,000 Debt Increase $ 1,000,000 Balance $1,200,000 $ 800,000

16 Alice (GP) and Bill s (LP) Outside Basis: A B Contribution $ 200,000 $ 800,000 Debt Increase $ 1,000,000 Balance $1,200,000 $ 800,000 Income $ 200,000 $ 800,000 Balance $1,400,000 $ 1,600,000 Alice (GP) and Bill s (LP) Outside Basis: A B Contribution $ 200,000 $ 800,000 Debt Increase $ 1,000,000 Balance $1,200,000 $ 800,000 Income $ 200,000 $ 800,000 Balance $1,400,000 $ 1,600,000 Deemed Distribution - -$1,000,000 - Debt Reduction Liquidating -$ 400,000 -$ 1,600,000 Distribution Ending Bal. $0 $0

17 What if the entity were an S Corporation from Inception (no E&P)? A B Contribution $ 200,000 $ 800,000 Income $ 200,000 $ 800,000 Balance $ 400,000 $ 1,600,000 Liquidating -$ 400,000 -$ 1,600,000 Distribution Ending Bal. $0 $0 Example 10-23: Buyer s Outside Basis Sam as Example 10-22, but before the sale of the land (when the land has appreciated from $2,000,000 to $3,000,000) Alice sells her 20% general partnership interest to Carol for $400,000, and Carol, the new general partner, is allocated $1,000,000 of partnership debt. Alice recognizes $200,000 of gain on the sale of her partnership interest ($1,400,000 amount realized minus $1,200,000 outside basis). The partnership does not make an IRC sec. 754 election.

18 Carol s beginning outside basis is $1,400,000; however, her tax basis capital account remains at $200,000 following the sale. When the land is subsequently sold for $3,000,000 by the partnership for a gain of $1,000,000, Carol is allocated $200,000 (20%) of the gain (exactly what the selling partner, Alice, would have been allocated). After the land sale, Carol s outside basis (O.B.) is $1,600,000 ($1,400,000 beginning O.B. plus $200,000 (her gain on land sale). Tax and Book Capital Accounts A B C Contribution $ 200,000 $ 800,000 A sells to C $200,000 Income $ 800,000 $200,000 Balance $ 1,600,000 $400,000

19 Outside Basis A B C Contribution $ 200,000 $ 800,000 Debt Increase $ 1,000,000 Balance $1,200,000 $ 800,000 C s Purchase $1,400,000 Income $ 800,000 $ 200,000 Balance $ 1,600,000 $1,600,000 Liquidation The partnership liquidates and terminates. Carol receives $400,000 in liquidation of her interest in AB, and recognizes a capital loss on liquidation of $200,000 (IRC sec. 731) because her preliquidation outside basis is $600,000 Bill receives $1,600,000 in liquidation of his interest in AB, all a tax free recovery of his outside basis (IRC sec. 731).

20 Alice, Bill, and Carol s Tax (and Book) Basis Capital Accounts: A B C Contribution $ 200,000 $ 800,000 A sells to C $200,000 Income $ 800,000 $200,000 Balance $ 1,600,000 $400,000 Liquidating -$ 1,600,000 -$400,000 Distribution Ending Bal. $0 $0 Outside Basis A B C Contribution $ 200,000 $ 800,000 Debt Increase $ 1,000,000 Balance $1,200,000 $ 800,000 C s Purchase $1,400,000 Income $ 800,000 $ 200,000 Balance $ 1,600,000 $1,600,000 Deemed -$1,000,000 Distribution -- Debt Reduction Balance $ 1,600,000 $ 600,000 Liquidating -$ 1,600,000 -$ 400,000 Distribution Cap. $0 -$ 200,000 Gain/Loss Ending Bal. $0 0

21 Section 754 Election. If the partnership opted to make an IRC sec. 754 election, then Carol would have an additional $200,000 inside basis in the land (her IRC sec. 743(b) adjustment) at the time of purchase which would eliminate her gain on the land sale Example 10-24: AB Partnership Loss (IRC sec. 704(b)) Same facts as Example 10-22: o Alice and Bill form the AB calendar year Limited Partnership. o Alice, the general partner, contributes $200,000 to AB. o Bill, the limited partner, contributes $800,000 the AB. o The partnership agreement allocates profits and losses 20% to Alice and 80% to Bill. o The partnership borrows $1,000,000 from a bank (recourse debt) and purchases land held for sale for $2,000,000. The debt is secured by the land. o The debt is allocated 100% to Alice, the general partner, as a result of her state law liability for partnership debts (IRC sec. 752). However, the land (held for sale) subsequently sells for $400,000, and produces an ordinary loss of $1,600,000 ($400,000 sales price minus $2,000,000 adjusted basis)

22 Because Ltd. Ptr. Bill lacks a deficit restoration obligation, the loss is allocated: o Alice -- $800,000 of ordinary loss. o Bill -- $800,000 of ordinary loss. Note: losses are allocated 50%-50% but the partnership agreement indicates that losses are shared 20% to Alice and 80% to Bill. The SEE test alters the 20/80 division because it prevents Bill s capital account from having a deficit balance. Alice and Bill s Tax (and Book) Basis Capital Accounts: A B Total Beg. Bal. $ 200,000 $ 800,000 $ 1,000,000 Loss -$ 800,000 -$ 800,000 -$ 1,600,000 Balance -$ 600,000 $0 -$ 600,000 Contrib. by $ 600,000 $0 $ 600,000 Alice (to pay debt) Ending Cap. $0 $0 $0

23 Alice and Bill s Outside Basis: A B Beg. Bal. $ 200,000 $ 800,000 Debt Increase $ 1,000,000 Balance $1,200,000 $ 800,000 Sale Loss -$ 800,000 -$ 800,000 End. Bal. $400,000 $ 0 Alice and Bill s Outside Basis: A B Beg. Bal. $ 200,000 $ 800,000 Debt Increase $ 1,000,000 Balance $1,200,000 $ 800,000 Sale Loss -$ 800,000 -$ 800,000 End. Bal. $400,000 $ 0 Deemed Distrib. -- -$400,000 Debt Reduction From Sales Proceeds A s Cap. Contrib. $600,000 $0 Deemed Distrib $600,000 $0 Debt Reduction with A s Capital End. Basis $ 0

24 What if the entity were an S Corporation from Inception (no E&P)? The $1,600,000 of land sale loss must be allocated pro-rata per share per day so Alice is allocated $320,000 (20%) and Bill is allocated $1,280,000 (80%) of the $1,600,000 loss. Alice can deduct only $200,000 (her pre-loss stock basis) of the loss--the other $120,000 of loss is suspended per IRC sec. 1366(d)(1). Bill can deduct only $800,000 (his pre-loss stock basis) of the loss--the other $480,000 of loss is suspended. Alice and Bill s S corporation Stock Basis: A B Beginning $ 200,000 $ 800,000 Loss -$ 320,000 -$ 1,280,000 End. Bal. $ 0 $0 Suspended Loss - $120,000 - $480,000 $600,000 of Suspended Losses

25 When, on liquidation (or other agreement by the lender), the S corporation is relieved of the $600,000 of debt, then the S corporation at the entity level --can exclude the COD income (IRC sec. 108(d)(7)(A)) The $600,000 of suspended losses disappear as attributes of the S corporation. Example 10-25: LLC Owner Guarantees Drive Loss Allocations Formation Alice and Bill form the AB LLC taxed as a partnership. The partnership borrows $1,000,000 from a bank and purchases land held for sale for $2,000,000. The debt is secured by the land. Because the entity is an LLC, neither partner is obligated to restore capital account deficits by operation of state law. Alice guarantees payment for $200,000 of AB s debt. Bill guarantees payment for $800,000 of AB s debt

26 The land sells for $400,000, and produces an ordinary loss of $1,600,000 ($400,000 sales price minus $2,000,000 adjusted basis) The $1,600,000 loss is allocated $320,000 (20%) to Alice and $1,280,000 (80%) to Bill. Alice and Bill s Tax (and Book) Basis Capital Accounts: A B Total Beginning $ 200,000 $ 800,000 $ 1,000,000 Loss -$ 320,000 -$ 1,280,000 -$ 1,600,000 Balance -$ 120,000 -$480,000 -$ 600,000 Capital $ 120,000 $480,000 $ 600,000 Contrib. (per the debt guarantee) Ending Cap. $0 $0 $0

27 Alice and Bill s Tax Basis Outside Basis: A B Beginning $ 200,000 $ 800,000 Debt Increase $ 200,000 $ 800,000 Balance $400,000 $1,600,000 Loss -$ 320,000 -$ 1,280,000 Balance $ 80,000 $ 320,000 Deemed Distrib. -- -$ 80,000 -$ 320,000 Debt Reduction From Sales Proceeds Cap. Contrib. to $120,000 $480,000 Pay Debt Deemed Distrib $120,000 - $480,000 Debt Reduction From Capital Contrib. End. Basis $0 $0 Observation #1: If Bill refused to guarantee the debt, and instead agreed in the LLC agreement to a limited capital account deficit restoration obligation (DRO). Same result as a guarantee? NO per Hubert

28 Observation #2: If the entity were a limited partnership, and Alice the general partner (Bill the limited partner), could Bill be allocated 80% of the loss and 80% of the debt with a guarantee? How does it differ from an LLC? Only if Bill agreed to waive his right to collect from the Gen. Ptr. Alice) Observation #3: Can Alice and Bill claim a business bad debt loss when they are forced to pay on the guarantees? Not without a basis in the debt.

29 10-49 Example 10-26: General Partners Where One Partner Defaults on DRO Alice and Bill are both general partners and the partnership has a $1,600,000 land sale ordinary loss which is allocated $320,000 (20%) to Alice and $1,280,000 (80%) to Bill. Alice has a capital account deficit of $120,000 and Bill s capital account deficit is $480,000. Bill defaults and Alice is forced to pay the entire $600,000 of debt. When the partnership liquidates, assume that general partner Bill, insolvent, defaults on his $480,000 deficit restoration obligation, and general partner Alice is forced to pay the entire remaining partnership debt of $600,000. What are the tax consequences? If Alice pays Bill s $480,000, she is entitled to a business bad debt deduction of $480,000. Bill has COD income.

30 Example Reverse 704(c) Built-in Loss Alice and Bill form the AB calendar year Limited Partnership. Alice, the general partner, contributes $200,000 to AB. Bill, the limited partner, contributes $800,000 the AB. The partnership borrows $1,000,000 from a bank (recourse debt) and purchases land held for sale for $2,000,000. The debt is secured by the land. Subsequently, the land depreciates in value from $2,000,000 to $1,200,000. Carol joins the partnership as a 50% general partner, is allocated $500,000 (50%) of the debt, and contributes $200,000 of capital. The partnership opts to revalue the partnership capital accounts when Carol joins, so the book value of the land is reduced from $2,000,000 to $1,200,000 and the $800,000 reduction in value is reflected in Alice (-$160,000) and Bill s (- $640,000) book capital accounts (IRC sec. 704(b)). No change is made to their tax basis capital accounts.

31 Subsequently, the land appreciates from $1,200,000 to $1,400,000, and the partnership sells the land for $1,400,000 so the partnership realizes a tax loss of $600,000 ($1,400,000 sales price minus $2,000,000 adjusted basis) on the sale. The partnership realizes a book gain on the land sale of $200,000--allocated 10%/40%/50% to Alice, Bill, and Carol respectively ($1,400,000 sales price minus $1,200,000 book basis). How is the $600,000 tax loss allocated among the partners? The Traditional Method: Capital Accounts: A (Tax) A (Book) B (Tax) B (Book) C (Tax) C (Book) Beg. $ 200,000 $200,000 $ 800,000 $800,000

32 How is the $600,000 tax loss allocated among the partners? The Traditional Method: Capital Accounts: A (Tax) A (Book) B (Tax) B (Book) C (Tax) C (Book) Beg. $ 200,000 $200,000 $ 800,000 $800,000 Adj. Value -$160,000 -$640,000 When Carol Carol Joins Balance $ 200,000 $40,000 $800,000 $160,000 $200,000 $200,000 The Traditional Method Benefits Carol -- Her $100,000 Economic Gain is not Taxed Capital Accounts: A (Tax) A (Book) B (Tax) B (Book) C (Tax) C (Book) Beg. $ 200,000 $200,000 $ 800,000 $800,000 Adj. Value -$160,000 -$640,000 When Carol Carol Joins Balance $ 200,000 $40,000 $800,000 $160,000 $200,000 $200,000 Gain/Loss -$120,000 $20,000 -$480,000 $80,000 $100,000 on sale Balance $80,000 $60,000 $320,000 $240,000 $200,000 $300,000

33 Alice, Bill, and Carol s Outside Basis: A B C Beg. $ 200,000 $ 800,000 Debt Increase $ 1,000,000 Balance $ 1,200,000 $ 800,000 C s capital for $200,000 50% GP Interest C is allocated -$ 500,000 $500,000 50% of Debt Balance $ 700,000 $ 800,000 $700,000 Land Sale Loss - $ 120,000 - $ 480,000 Balance $ 580,000 $ 320,000 Deemed Distrib. -$ 500,000 -$ 500, Debt Reduction Following Sale Balance $ 80,000 $320,000 $ 200,000 Liquidation: Following the land sale for $1,400,000, the partnership applies $1,000,000 of the sales proceeds to the debt; therefore, the partnership had $600,000 ($400,000 sales proceeds plus $200,000 of Carol s contributed cash) of cash to distribute in a liquidating distribution to Alice, Bill, and Carol: Alice: $ 60,000 (10%) -- loss of $20,000 (IRC sec. 731) Bill: $ 240,000 (20%) loss of $80,000 (IRC sec. 731) Carol: $ 300,000 (50%) gain of $100,000 (IRC sec. 731)

34 Alice, Bill, and Carol s Outside Basis: A B C Balance $ 80,000 $320,000 $ 200,000 Liquidating - $ 60,000 -$ 240,000 -$300,000 Dist. Gain/-Loss - $20,000 - $80,000 $100,000 End. Basis $0 $0 $0 Remedial Method of Loss Allocation Alice, Bill, and Carol s Capital Accounts A (Tax) A (Book) B (Tax) B (Book) C (Tax) C (Book) Beg. $ 200,000 $200,000 $ 800,000 $800,000 Adj. Value -$160,000 -$640,000 When Carol Joins Balance $40,000 $800,000 $160,000 $200,000 $200,000 Gain/Loss -$120,000 $20,000 -$480,000 $80,000 $100,000 on land sale Remedial -$ 20,000 - $80,000 $100,000 Allocation Balance $60,000 $60,000 $240,000 $240,000 $300,000 $300,000 The Remedial Method Benefits A & B who are allowed an additional $100,000 loss

35 Example 10-28: Forward IRC sec. 704(c) Built-in Loss. Assume that Alice and Bill contribute land, Blackacre, (held 20% by Alice and 80% by Bill as tenants in common) to a newly formed partnership with a fair market value (FMV) of $200,000 and a basis of $1,000,000 (Alice s share of Blackacre basis was $200,000; Bill s share was $800,000). Carol contributes cash of $200,000 for a 50% partnership interest. Alice is a 10% partner and Bill is a 40% partner Blackacre subsequently appreciates to $400,000 FMV and it is sold. Because the contribution of built-in loss property by Alice and Bill constitutes a forward IRC sec. 704(c) built-in loss, IRC sec. 704(c)(1)(C) applies. Pursuant to the 2014 proposed regulations (discussed in Chapter 8), the partnership s basis in Blackacre is $200,000 (FMV on the date of Alice and Bill s contribution of Blackacre to the partnership). Alice has a private basis adjustment in Blackacre of $160,000 (($1,000,000 - $200,000) x 20%) and Bill has a private basis adjustment in Blackacre of $640,000 ($1,000, ,000) x 80%).

36 Therefore, when Blackacre is sold, the recognized gain at the partnership level is $200,000 ($400,000 - $200,000), and it is allocated 10%, 40%, and 50% to A, B, and C respectively. Carol recognizes $100,000 of gain, which matches the economics of the deal for her (her 50% interest in Blackacre appreciated by $100,000). Alice is allocated $20,000 of partnership level gain (10% x 200,000), representing the appreciation that arose following Carol s contribution to the partnership, but she is allowed to offset the gain on sale with her private IRC sec. 704(c)(1)(C) basis adjustment of $160,000. As a result, she recognizes a net loss of $140,000. Example 10-29: Profit Allocation and Minimum Gain Drives Debt Share With Nonrecourse Debt Alice and Bill form the AB LLC taxed as a partnership. Alice contributes $200,000 to AB. Bill contributes $800,000 the AB. The partnership agreement allocates profits and losses 20% to Alice and 80% to Bill. Liquidation proceeds are distributed in accordance with capital accounts. However, all depreciation is allocated to Bill; if the depreciable asset is sold at a gain, the gain is first allocated to Bill to the extent he was allocated depreciation, and the balance is allocated 20% to Alice and 80% to Bill (i.e., a gain chargeback provision).

37 The partnership borrows $1,000,000 from a bank and purchase a depreciable building (on leased land) for $2,000,000. The debt is secured by the building and no debt principal is paid until the land is sold. The debt is nonrecourse debt because no partner is personally liable for the debt. The partnership agreement contains a minimum gain chargeback provision. The debt is initially allocated based upon profit share (Tier Three (IRC sec. 752 regulations)) excess nonrecourse debt of $1,000,000), and, initially, Alice and Bill are allocated $200,000 and $800,000 of the debt respectively (based upon profit share). Depreciation The partnership claims tax depreciation on the building of $1,600,000 (for simplicity ignore the fact that the depreciation would be spread over several years). How is the depreciation allocated?

38 Balance Sheet After $800,000 of Depreciation Assets: Tax and Book Basis Building Adj. Basis. $1,200,000 Liabilities: Nonrecourse Debt $1,000,000 Capital: Alice $200,000 Bill $0 Debt + Capital $1,200,000 Depreciation Allocation: First $800,000 to Bill The next $200,000 must be allocated to Alice No nonrecourse deductions until the depreciation exceeds $1,000,000 (the nonrecourse debt principal)

39 Balance Sheet After $1,000,000 of Depreciation Assets: Tax and Book Basis Building Adj. Basis. $1,000,000 Liabilities: Nonrecourse Debt $1,000,000 Capital: Alice $0 Bill $0 Debt + Capital $1,000,000 The remaining $600,000 of depreciation can be allocated to Bill because he has a deemed deficit restoration obligation for his share of minimum gain.

40 Does Bill have enough outside basis to claim the loss? Yes, Bill s share of minimum gain increases his debt share. Example 10-30: Recourse Debt Due to Guarantee Return to the original facts in Example 10-29, what if the LLC debt were guaranteed -- Alice guarantees $200,000 while Bill guarantees $800,000. As a result of the co-guarantees, the debt is recourse debt (AKA: partner nonrecourse debt). Otherwise, all facts match Example For the original facts in Example 10-29, the answer is the same based upon Rev. Rul : First $800,000 of depreciation to Bill Second $200,000 of depreciation to Alice Remaining $600,000 of depreciation to Bill.