Partnership Basis and At Risk Rules: The New Section 752 Regulations and More

60TH ANNUAL MNCPA TAX CONFERENCE November 17-18, 2014 Minneapolis Convention Center ONLINE RESOURCES Session Handouts Most session handouts are available on the MNCPA website. To access: Go to www.mncpa.org/materials Log in with your MNCPA username and password Note: Your conference registration fee must be paid in full to access session handouts online. CPE Transcript (Certificate of Attendance) Your official transcript will be available on the MNCPA website. To access: Go to www.mncpa.org/transcript Log in with your MNCPA username and password Note: Tax Conference transcripts will be available Friday, Nov. 21. MATERIALS DISCLAIMER Partnership Basis and At Risk Rules: The New Section 752 Regulations and More Michael Cole, MSPA, JD McGladrey LLP Minneapolis, MN Michael Cole, MSPA, JD, is a tax director and national leader in complex partnership structuring and compliance issues for McGladrey LLP. He has extensive experience in transactional and structuring engagements involving various entity forms. Cole began his career working at Ernst & Young, LLP as the first direct hire in the Transaction Advisory Services, Transaction Tax Center of Excellence and then moving on to serve as the head of taxation for Ironstate Holdings, LLC. These materials are provided for the exclusive, personal use of the customer. Any other reproduction, retransmission, republication or other use is expressly prohibited without prior written consent from the Minnesota Society of Certified Public Accountants (MNCPA) and/or the content author. The MNCPA makes no warranty, guarantee or representation as to the accuracy or completeness of these materials. The contents of these materials are subject to change without notice. The content authors and/or instructors are not engaged in rendering legal, accounting or professional service. If legal advice or other expert assistance is required, the services of a competent professional person should be sought.

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Partnership Basis and At Risk Rules: The New Section 752 Regulations & More Agenda: At Risk and 465 Basis in a Partnership Examples 1 & 2 752 The Past and Present Allocation of Debt Recourse and Nonrecourse Proposed 752 Regulations Examples 3 9 2 Page 1

At Risk and 465 3 At Risk: At-Risk and Section 465 - Determining Deductions I.R.C. 465 prevents taxpayers from taking a deduction in excess of the amount of risk as determined by the Code and associated regulations. There are two ways in which deductions allocated to an activity may be deductable by a taxpayer: - Deductions from an activity are generally allowed to the extent that there is income received or accrued in a taxable year. - In the alternative, losses in excess of income from an activity will be allowed to the extent that the taxpayer is at risk with respect to the activity at the close of the taxable year. See Treas. Reg. 1.465-2(a). 4 Page 2

At Risk: The amount considered at risk 465(b)(1): - In general. For purposes of this section, a taxpayer shall be considered at risk for an activity with respect to amounts including: The amount of money and the adjusted basis of other property contributed by the taxpayer to the activity, and Amounts borrowed with respect to such activity 5 At Risk: Determining at risk for borrowed amounts 465(b)(2): - Borrowed amounts. For purposes of this section, a taxpayer shall be considered at risk with respect to amounts borrowed for use in an activity to the extent that he: Is personally liable for the repayment of such amounts, or Has pledged property, other than property used in such an activity, as security for such borrowed amount (to the extent of the net fair market value of the taxpayer s interest in such property). - No property shall be taken into account as security if such property is directly or indirectly financed by indebtedness which is secured by property 6 Page 3

At Risk: Beginning Amount At Risk in a Partnership - Generally, a partner s amount at risk is equal to the taxpayer s basis plus debt allocation less amount protected against loss. - The amount that is at risk is thereafter adjusted for items impacting basis and borrowed funds. Treas. Reg. 7.465-2(a-b) 7 Basis in a Partnership 8 Page 4

Basis in Partnership Interest: Basis in a Partnership - Defined by Sections 722 and 723 Initial basis is of the property, including money, contributed by the partner in exchange for the interest 722 The basis of the property is equal to the adjusted basis that a partner held in such property increased by any gain triggered by 721(b), see 723. - Note: The impact of debt on basis of contributed property, the partner, and the alternative determination of basis under 705(b) are outside the scope of this presentation. Annual Adjustments to basis are completed under the rules of 705. 9 Basis in Partnership Interest Initial concepts - Inside Basis Basis of partnership assets - Outside Basis Partner s basis in partnership interest - Why are they different? - What is the impact if there is a difference? 743(b) or 734(b) adjustments (optional or mandatory) 10 Page 5

Basis in Partnership Interest Single Basis Concept - One single basis even though partners can own multiple classes of partnership interest - However, this single basis can have separate holding periods - IRS Legal Advice AM2012-001 Cannot allocate tax items to different interests in disregarded entity Rev. Rul. 84-53 - Partner has a unitary basis - Use FMV to determine portion sold - Liabilities complicate the issue 11 Basis in Partnership Interest Calculation of Basis - When do you calculate basis? A partner is only required to compute the basis of his partnership interest when the computation is necessary to determine his tax liability. When there has been a sale or exchange of all or a part of a partnership interest or a liquidation of a partner's entire interest in a partnership, the adjusted basis of the partner's interest should be determined as of the date of sale or exchange or liquidation Reg. 1.705-1(a)(1) 12 Page 6

Basis in Partnership Interest Calculation of Basis - Ordering Rules under 705(a) Increased by - Contributions to the partnership and purchases of partnership interests ( 722 and 742) - Taxable income of the partnership - Income of the partnership exempt from tax - The excess of the deductions for depletion over the basis of the property subject to depletion 13 Basis in Partnership Interest Calculation of Basis - Ordering Rules under 705(a) Decreased by - Distributions of the partnership ( 733) Money is considered distributed before other property if made simultaneously. Basis adjustments for separate distributions are made in chronological order. - Losses of the partnership - Depletion - See Rev. Rul. 66-94 comprehensive example of basis calculation and ordering rules 14 Page 7

Basis in Partnership Interest Contribution of property - Partner receives basis equal to adjusted basis in partnership property. Distribution of property - Partner s basis is decreased by adjusted basis in partnership property (with limitations) Exceptions to general rules for - Disguised sales - Shifting of liabilities could cause gain recognition - Liquidating distributions 15 Basis in Partner s Interest: Annual adjustments to a Partner s Basis in the Partnership: Increased by the sum of his distributive share for the taxable year and prior taxable years of: - Taxable income of the partnership as determined under section 703(a) - Income of the partnership exempt from tax under this title, and - The excess of the deductions for depletion over the basis of the property subject to depletion; Decreased (but not below zero) by distributions by the partnership as provided in section 733 and by the sum of his distributive share for the taxable year and prior taxable years of: - Losses of the partnership, and - Expenditures of the partnership not deductible in computing its taxable income and not properly chargeable to capital account; I.R.C. 705(a)(1-2) 16 Page 8

Basis in Partnership Interest Calculation of Basis - Alternative rule under 705(b) Partners basis is equal to their proportionate share of all assets - When can you apply this rule The partner cannot practicably apply the general rule set forth in 705(a) Reasonable to conclude that the result produced will not vary substantially from the result obtainable under the general rule 17 Basis in Partnership Interest A partner s basis cannot be reduced below zero - 704(d) provides that deductions cannot be taken to the extent they exceed the partner s basis - 731(a)(1) causes gain recognition on any cash distributions to the extent they exceed the partner s basis - 732(b) provides that the basis of property distributed on liquidation is equal to the adjusted basis in partner s interest in the partnership, exception for money 18 Page 9

Basis in Partnership Interest Partner s Basis and Partner s Capital Account - Generally, basis will equal the sum of Tax basis capital account, and Partner s share of liabilities. - Partners can have negative or deficit capital accounts 19 Basis in Partnership Interest Treatment of liabilities 752 - Increase in a partner's share of partnership liabilities are treated as cash contributions by the partner - Decrease in a partner's share of partnership liabilities are treated as cash distributions to the partner - A liability to which property is subject shall, to the extent of the fair market value of such property, be considered as a liability of the owner of the property. 20 Page 10

Basis in Partnership Interest 704(b) vs. Tax Basis - Initial value is fair market value for contributed property under 704(b) - On distribution of property, the value of the property must be booked up to reflect FMV with a corresponding adjustment to partner s 704(b) capital accounts - Book-ups can be made when other significant transactions occur. See Reg. 1.704-1(b)(2)(iv)(f) 21 Basis in Partnership Interest Other issues - A partner's note evidencing its obligation to make a future contribution to the partnership has no basis - Rev. Rul. 96-11 basis adjustment on charitable contribution of partnership property 22 Page 11

Example 1 Slide 1: Alex wishes to enter into a partnership with Bailey. They form a Delaware LLC and decide to use the default status as a partnership for tax reasons. The organization maintains its books and records in accordance with Treas. Reg. 1.704-1(b). To capitalize the organization, Alex contributes depreciable machinery with a basis of $750,000 and a fair market value of $1,000,000. Bailey contributes cash of $1,000,000. The organization has no other debts or obligations. 23 Example 1 Slide 2: Alex has a stated capital account for calculations under 704 of $1,000,000. Her amount at risk, however, is only $750,000 because 722 provides that her basis is equal to the basis in the property determined under 723 increased by any gain under 721(b). Accordingly, her basis in the property contributed to the partnership was $750,000 no gain was recognized under 721(b) yielding an initial amount at risk of $750,000. 24 Page 12

Example 1 Slide 3: Bailey has a stated capital account for calculations under 704 of $1,000,000. Her amount at risk is $1,000,000 because 722 provides that her basis is equal to the basis in the property determined under 723 increased by any gain under 721 (b). Accordingly, her basis in the property contributed to the partnership was $1,000,000 no gain was recognized under 721(b) yielding an initial amount at risk of $1,000,000. 25 Example 2 Slide 1: Same facts as Example 1. At the end of the first year of operations the organization had a $2,000,000 loss. In a 50/50 partnership each person would receive an allocation loss equal to $1,000,000. For 704 accounting purposes each account would be reduced by $1,000,000 leaving a remaining capital account for tax book of $0. 26 Page 13

Example 2 Slide 2: Bailey had at risk basis at the end of the year equal to $1,000,000. The allocation of loss is therefore fully deductible on her personal return. Her at risk basis is now reduced to $0 the same as her 704 capital account. 27 Example 2 Slide 3: Alex had an at risk basis equal to $750,000 at the end of the year. The allocation of loss is available to offset the at risk value equal to $750,000. Alex may not have an at risk basis less than $0 the remaining $250,000 is not deductible on Alex s personal return as a suspended loss Alex will also now have a 704 capital account of $0. 28 Page 14

752 The Past and the Present 29 752 The Past and the Present: Historic The Simple Methods Prior to 1988 Prior Treas. Reg. 1.752-1(e) provided a simple method for the allocation of debt amongst the members of an organization. General Partners allocated liabilities in accordance with their ratios for sharing losses. Liabilities that are nonrecourse are allocated to partners in accordance with their profit sharing ratios. The major change in the law arises from the case Raphan v. U.S., 3 Cl. Ct. 457 (1983), rev d, 759 F.2d 879 (Fed. Cir. 1985). 30 Page 15

752 The Past and the Present: Historic Raphan v. U.S. Id. - A Limited Partnership had several investors and various debt obligations; however, the guarantees of the general partner w outside of the partnership agreement. - The Federal Claims Court had the first decision and provided that this was not made in a partner capacity and therefore the debt remained nonrecourse and is to be allocated to all partners according to profit ratios. - This appears to be inconsistent with the position that many thought should apply it was eventually overturned. 31 752 The Past and the Present: Historic Raphan v. U.S. The Backlash - The Act [P.L. 98-369] provides specifically that the Claims Court decision in Raphan v. United States is not to be followed for purposes of applying section 752 or the regulations thereunder. In addition, the Treasury is to revise and update its regulations under section 752, as soon as practicable, to reflect the overruling of the Raphan decision and to take account of current commercial practices and arrangements relating to partnership liabilities, including regulations concerning the treatment of guarantees, assumptions, indemnity agreements, and other similar arrangements. EXPLANATION OF THE REV. REDUCTION ACT OF 1984, JOINT COM. TAXATION 250 (Joint Comm. Print 1984). 32 Page 16

752 The Past and the Present: Current Generally, The Deficit Reduction Act of 1984 (P.L. 98-369) fortified the concept of At-Risk allocations of liabilities in entities taxed as partnerships It focused on preventing partners from deducting losses in excess of the amounts which the taxpayer actually risks losing as a result of an investment. Explanation of the Rev. Reduction Act of 1984, Joint Com. Taxation 250 (Joint Comm. Print 1984). 33 Allocation of Debt Recourse and Nonrecourse 34 Page 17

Allocation of Debt Recourse Debt - Recourse if and to the extent one or more partners (or related persons) bear the economic risk of loss (Reg. 1.752-1) - Economic risk of loss Based on constructive liquidation where a partner (or related person) is not entitled to reimbursement - All obligations are recognized - All of the partnership s assets, including cash, have a value of zero - Partnership disposes of all property - Income and loss is allocated to partner - Partnership liquidates 35 Current Law - 752: Recourse Liabilities Economic Risk of Loss: Measured by his ultimate responsibility to pay the creditor or to contribute additional funds to the partnership Constructive Liquidation - definition: - Partnership assets become worthless - Liabilities become due and payable in full - Partnership disposes of assets in a taxable exchange for no consideration other than relief from limited liabilities - Partnership allocates its items of income, gain, loss, deduction and credit among the partners and liquidates Direct Payment Obligations: - Economic risk also includes direct payment obligations - Can include guarantees, assumptions, indemnities and similar arrangements - Limited partners may not get the debt allocated to them if they would be entitled a reimbursement Disproportionate loss sharing: - Allocate losses in accordance with 704(b) and corresponding liabilities under 752 36 Page 18

Allocation of Debt Qualified Nonrecourse Financing (Reg. 1.465-27) - Allocated under the nonrecourse debt rules. - No one is personally liable for repayment. - Used in the activity of holding real property. - Loaned or guaranteed by: Federal, state, or local government, or A person regularly involved in the business of lending (i.e., bank or savings and loan association) - Secured by real property used in the activity. 37 Allocation of Debt Nonrecourse debt (Reg. 1.752-3(a)) - No partner or related person bears economic risk of loss - Three tiers of allocations Partner s share of minimum gain under 704(b) Partner s share of 704(c) minimum gain Excess nonrecourse debt - Partner s share of profits - Partnership agreement may specify provide it is consistent with allocations of some significant item - Allocate based on deductions related to debt - May first allocate based on 704(c) gain not considered in tier 2 38 Page 19

Allocation of Debt Nonrecourse Allocations Must allocate liabilities to partners that would bear the economic risk of loss with those liabilities Practical thought: If the partnership defaulted on its obligations, who would be on the hook from personal funds w/o right to reimbursement. 39 Nonrecourse Deductions Allocations of deductions attributable to nonrecourse debt do not have substantial economic effect - Lender (not partner) bears any economic loss Allocations based on partner s interest in the partnership (Reg. 1.704-2) 40 Page 20

Proposed 752 Regulations 41 Proposed 752 - Introduction - The Proposed 752 Regulations maintain the general rule of allocating excess nonrecourse liabilities based on each partner s profit interest. The practical application of calculating a partner s true share of profits in the partnership is nearly impossible. Under the current regulations, there are three safe harbors that can be used to allocate excess nonrecourse liabilities. Using these safe harbors enables the partnership to abide by the law, while still giving some flexibility. 42 Page 21

Current Law - 752: Nonrecourse Liabilities Exculpatory Liabilities: - Liability that is nonrecourse in that no partner has any economic risk of loss related to the liability, but is not secured by specific partnership property (i.e. recourse to the partnership but not to any of the partners) - Often an issue in LLCs and LLPs - General partnerships do not have exculpatory liabilities because there is always at least one general partner that is personally liable for all liabilities Bifurcated Debt: - Occurs when a partner(s) bear the economic risk of loss with respect to a portion of the liability but not to the entire liability. The portion where the partner bears the economic risk of loss is treated as recourse specifically to that partner as a recourse liability. The remainder is treated as a nonrecourse liability. Partner Nonrecourse Loans and Guarantees: - A partner who lends money to the partnership on a nonrecourse basis bears the economic risk of loss for the liability - Same holds true for a partner guarantees an otherwise nonrecourse liability 43 Current Law - 752: Nonrecourse Liabilities Three Tiers: - Partner s share of partnership minimum gain as determined under 704(b) Regs concerning allocation of nonrecourse deductions - Amount of taxable gain that would be allocated to a partner under 704(c) principles if the partnership disposed of all property subject to non-recourse liabilities in a taxable transaction in full satisfaction of such liabilities and for no other consideration - Excess nonrecourse liabilities as determined in accordance with the partner s share of partnership profits The partnership agreement may state an allocation if reasonably consistent with the allocation of some significant item of partnership income or gain amount the partners. 44 Page 22

Proposed Regulations 752 Prop. Reg. 1.752-2(b)(ii) has largest changes: - To recognize a liability as recourse it must satisfy (A-G) - Further, there is a review under Prop. Reg. 1.752-2(k) when state law or other function would required repayment to determine the Net Value of partners other than individuals and estates Prop. Reg. 1.752-2(b)(iii) is expanded to accommodate a Net Value Requirement for all partners other than individuals and estates 45 Proposed Regulations 752 (Summary) (A) The partner or related person is - Required to maintain a commercially reasonable net worth throughout the term of the payment obligation; or - Subject to commercially reasonable contractual restrictions on transfers of assets for inadequate consideration, (B) The partner or related person is required periodically to provide commercially reasonable documentation regarding financial condition, (C) The term of the obligation does not end prior to the liability, (D) The payment obligation does not require that the primary obligor or any other obligor with respect to the partnership liability directly or indirectly hold money or other liquid assets in an amount that exceeds the reasonable needs of such obligor, (E) The partner or related person received arm's length consideration for assuming the payment obligation 46 Page 23

Proposed Regulations 752 (Summary) (F) In the case of a guarantee or similar arrangement, the partner or related person is or would be liable up to the full amount of such partner's or related person's payment obligation if, and to the extent that, any amount of the partnership liability is not otherwise satisfied. For purposes of this paragraph (b)(3)(ii)(f), the terms of a guarantee or similar arrangement will be treated as modified by any right of indemnity, reimbursement, or similar arrangement regardless of whether that arrangement would be recognized under paragraph (b)(3) of this section. However, the preceding sentence does not apply to a right of proportionate contribution running between partners or related persons who are co-obligors with respect to a payment obligation for which each of them is jointly and severally liable. 47 Proposed Regulations 752 (Summary) (G) In the case of an indemnity, reimbursement agreement, or similar arrangement, the partner or related person is or would be liable up to the full amount of such partner's or related person's payment obligation if, and to the extent that, any amount of the indemnitee's or other benefitted party's payment obligation is satisfied. The indemnity, reimbursement agreement, or similar arrangement only satisfies this paragraph (b)(3)(ii)(g) if, before taking into account the indemnity, reimbursement agreement, or similar arrangement, the indemnitee's or other benefitted party's payment obligation is recognized under paragraph (b)(3) of this section or would be recognized under paragraph (b)(3) of this section if such person were a partner or related person. For purposes of this paragraph (b)(3)(ii)(g), the terms of an indemnity, reimbursement agreement, or similar arrangement will be treated as modified by any further right of indemnity, reimbursement, or similar arrangement regardless of whether that further arrangement would be recognized under paragraph (b)(3) of this section. However, the preceding sentence does not apply to a right of proportionate contribution running between partners or related persons who are co-obligors with respect to a payment obligation for which each of them is jointly and severally liable. 48 Page 24

Proposed Regulations 752 (iii) Satisfaction of obligation. (Summary) (B) Net value requirement. - In determining the extent to which a partner or related person other than an individual or a decedent's estate bears the economic risk of loss under paragraph (b)(1) of this section for a partnership liability other than a trade payable, a payment obligation is recognized only to the extent of the net value of the partner or related person as of the allocation date (as defined in paragraph (k)(2)(iv) of this section) that is allocated to the partnership liability. A partner or related person's net value is determined under the rules of paragraph (k) of this section. (C) Information to be provided regarding net value. - A partner that may be treated as bearing the economic risk of loss for a partnership liability based upon an obligation under paragraph (b)(1) of this section (a 1.752-2(b)(1) payment obligation) of a person, including the partner, other than an individual or a decedent's estate, must provide information to the partnership as to that person's net value that is appropriately allocable to the partnership's liabilities on a timely basis. 49 Example 3 Slide 1: Prop. Reg. 1.752-2(f) Example 3 E, LLC F, LLC 50% 50% EF, LP 50 Page 25

Example 3 Slide 2: Prop. Reg. 1.752-2(f) Example 3 Limited Liability Company EF purchases assets for $25,000 - $10,000 of cash originally contributed - $15,000 of debt F (the limited partner) guarantees the debt in full after the lender has extinguished all other sources The organization uses 704 accounting with a QIO E is solvent with a Net Value of $15,000 or more 51 Example 3 Slide 3: Prop. Reg. 1.752-2(f) Example 3 Under the laws of most states - A general partner will have an unlimited deficit restoration obligation - Limited partners will not have such obligation Section 704 rules require the limited partner to have a qualified income offset for the amount of limited restoration to satiate the economic effect rules F does not have an allocation of recourse liabilities because E has enough value under (b)(iii) to pay the obligations of the LLC in the event of a default and therefore F does not have an obligation that requires an allocation of debt and E has $15,000 of a recourse liability 52 Page 26

Example 4 Slide 1: Prop. Reg. 1.752-2(f) Example 12 A B C 33% 33% 33% A, B, & C are Individuals ABC, LLC 53 Example 4 Slide 2: Prop. Reg. 1.752-2(f) Example 12 ABC, LLC borrows $1,000 for an asset purchase A agrees to be obligated in the amount of 25% of any uncollected value - This constitutes a partial guarantee under Prop. Reg. 1.752-2(b)(ii)(F) and therefore is not recognized for the allocation of recourse debt - Assume $250 is not collected, A would only be liable for $62.50 The debt is, thus, nonrecourse and allocated under 1.752-3 54 Page 27

Example 5 Slide 1: Prop. Reg. 1.752-2(f) Example 11 A B C 33% 33% 33% A, B, & C are Individuals ABC, LLC 55 Example 5 Slide 2: Prop. Reg. 1.752-2(f) Example 11 ABC, LLC takes out a loan for $1,000 A agrees to pay $300 for any uncollected amount B agrees to pay up to $200 if the bank does not recover $200 C agrees to indemnify A for $50 and all of B s obligation 56 Page 28

Example 5 Slide 3: Prop. Reg. 1.752-2(f) Example 11 B s guarantee is not recognized under Prop. Reg. 1.752-2(b)(ii)(F) because it is not an obligation related to any amount of unrecovered value; instead it is only if not more than $200 is recovered C s indemnity of B is not recognized because for C to have a valid indemnity it must be related to a recognized liability - In other words, because B did not have a recognized liability C cannot have a recognized indemnity 57 Example 5 Slide 4: Prop. Reg. 1.752-2(f) Example 11 A has a valid obligation to pay the amount of $300 However, C has now indemnified A for the first $50 A s obligation is now modified and accordingly A no longer has a payment for any amount A s obligation is no longer recognized under (F) 58 Page 29

Example 5 Slide 5: Prop. Reg. 1.752-2(f) Example 11 C has a valid obligation because but for his indemnity, A would have had a fully valid and recognized obligation A & B do not have any recognized obligations The remaining $950 is allocated as nonrecourse debt under 1.752-3 59 Overlapping Economic Risk of Loss Prop. Treas. Reg. 1.752-2(a): When a the value of the overall economic risk of loss is in excess to the partnership obligations the proportionate amount of the risk is allocated to each member by using the following formula Recourse Debt X Portion of Economic Risk Total Economic Risk 60 Page 30

Example 6 Slide 1: Overlapping Economic Risk of Loss A & B form partnership AB and agree to waive contribution rights against one another. To facilitate business needs the partnership takes out a loan for $1,000 to which A guarantees the total 1,000 and B guarantees 500. The Economic Risk of Loss of A & B is 1,500 (1,000 + 500) This is in excess of the 1,000 outstanding loan and therefore is overlapping Calculating the Recourse Allocations - A s recourse allocation is 1,000 * (1,000/1,500) = 667 - B s recourse allocation is 500 * (1,000/1,500) = 333 Prop. Treas. Reg. 1.752-2(f) Example (9). 61 Prop. Treas. Reg. 1.752-3: Nonrecourse Allocation Issues Nonrecourse & Liquidation Ratios - The alteration to the nonrecourse allocations provides that after accounting for: Partner s share of minimum gain under 704(b) Partner s share of 704(c) minimum gain Allocations may be completed in accordance with members liquidation ratio, meaning, the portion of liquidation proceeds allocated to that member in liquation. Remaining Nonrecourse Debt X Partner s Capital Account Total All Capital Accounts 62 Page 31

Example 7 - Slide 1:Prop. Treas. Reg. 1.752-3 Prop. Reg. 1.752-3(c) Example 2. X & Y create XY, LLC by contributing $100 each for a total capital of 200. The organization liquidates in accordance with positive capital accounts and uses 704 as its basis for maintaining books & records. AB borrows 50 to purchase two parcels of land. Parcel A has a value of 50 and parcel B with a value of 200. The debt is general organizational debt not secured by any asset (in other words not Qualified Financing). 63 Example 7 - Slide 2:Prop. Treas. Reg. 1.752-3 Year 1 There is no activity in the organization or depreciation on the land. - XY is a 50/50 partnership X s liquidation value is calculated as * (125/250) = 125 Y s liquidation value is calculated as * (125/250) = 125 64 Page 32

Special Rules for Related Parties: Prop. Reg. 1.752-4 (Generally) When a related party, that is not a partner, guarantees debt of the partnership, the related party(ies) shall share equally in the portion of related debt. Prop. Reg. 1.752-4(b)(3) When a partner guarantees debt of the organization, that debt is allocated at the lowest level of direct ownership up to the amount of the guarantee. Prop. Reg. 1.752-4(b)(2) Entities and transactions structured to avoid the related party allocations under the proposed regulations will be void and such parties will be deemed related for the application of the regulation. Prop. Reg. 1.752-4(b)(4) 65 Example 8 Slide 1: Prop. Reg. 1.752-4 Example 7 A is an Individual A 100% 50% X 50% X & Y are Corporations Y 100% P, LLC P is a Limited Liability Company 66 Page 33

Example 8 Slide 2: Prop. Reg. 1.752-4 Example 7 Partnership P takes out a loan of $1,000 Company Y guarantees 100% of the debt Neither X nor A are the lender of the funds (b)(2) of the proposed regulations will not apply and therefore X & A are treated as related to Y for determining the allocation of recourse obligations Consequently, X & A share equally in the recourse allocation at $500 each 67 Example 9 Slide 1: Prop. Reg. 1.752-4 Example 4 A is an Individual 100% A 100% 50% X Y 79% 50% 21% 50% X, Y, & Z are Corporations Z P, LLC P is a Limited Liability Company 68 Page 34

Example 9 Slide 2: Prop. Reg. 1.752-4 Example 4 Partnership P takes out $2,000 of debt X agrees to guarantee $1,200 of the debt Z guarantees all $2,000 69 Example 9 Slide 3: Prop. Reg. 1.752-4 Example 4 Under (b)(2) the determination of allocation of recourse liabilities to which X has guaranteed is made as though X is unrelated to any other partner - As a result, X is treated as having recourse allocation of $1,200 Z guaranteed all $2,000 of the obligation - The partnership may only allocate $2,000 and X has an automatic allocation of $1,200 because X is a direct partner with an obligation - The remaining $800 is therefore available for allocation and, similar to Example 8, the related parties (X & Y) to Z will share the allocation evenly Total Recourse allocations: - X gets $1,600 ( 1,200 + ½ * 800 ) - Y gets $400 ( ½ * 800 ) 70 Page 35

Presenter Michael Cole, MS, JD - Senior Manager - McGladrey, LLP - 612.376.9303 - Mike.Cole@mcgladrey.com 71 McGladrey LLP is the U.S. member of the RSM International ( RSMI ) network of independent accounting, tax and consulting firms. The member firms of RSMI collaborate to provide services to global clients, but are separate and distinct legal entities which cannot obligate each other. Each member firm is responsible only for its own acts and omissions, and not those of any other party. McGladrey, the McGladrey signature, The McGladrey Classic logo, The power of being understood, Power comes from being understood and Experience the power of being understood are trademarks of McGladrey LLP. Page 36

60TH ANNUAL MNCPA TAX CONFERENCE November 17-18, 2014 Minneapolis Convention Center, Minneapolis, MN Please rate the following using the scale below: 5=Excellent, 4=Very Good, 3=Average, 2=Fair, 1=Poor F1. Partnership Basis and At Risk Rules: The New Section 752 Regulations and More Excellent Poor Relevancy of Topic 5 4 3 2 1 Stated Objectives Met 5 4 3 2 1 Overall Satisfaction 5 4 3 2 1 Michael Cole, MSPA, JD Knowledge of Subject 5 4 3 2 1 Presentation Skills 5 4 3 2 1 Quality of Materials 5 4 3 2 1 Engagement of Participants 5 4 3 2 1 Do you have any additional feedback regarding the instructor and/or materials? If so, please share it with us. What would you like to learn at the 2015 conference? Who would you like to hear speak at the 2015 conference? Thank you for your feedback and suggestions. We appreciate your input. Minnesota Society of Certified Public Accountants www.mncpa.org 952-831-2707