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Election under Regs. Sec. 1.752-5(b) can benefit partnerships and their partners.

The new final regulations under Sec. 752 provide rules for allocating partnership liabilities. These regulations replace the temporary regulations issued on Dec. 30, 1988 and amended on Nov. 21, 1989, and the proposed regulations released on July 12, 1991 The final regulations apply to any liability incurred or assumed by a partnership on or after Dec. 28, 1991.

The temporary regulations generally apply to partnership liabilities incurred or assumed after Jan. 29, 1989 and before Dec. 28, 1991. Partnership liabilities that predate the final and temporary regulations are subject to the prior final regulations (the "old regulations") However, the final regulations allow a partnership to elect a "Sec. 752 election" to apply the final regulations to all of its liabilities as of the beginning of its first tax year ending on or after Dec. 28, 1991. In certain instances, a partnership land its partners can benefit by choosing the Sec. 752 regulations to which it will be subject.

Under the old regulations, recourse liabilities are generally allocated to partners in accordance with the partner's loss-sharing ratios. Nonrecourse liabilities are 'shared in accordance with the partner's profit-sharing ratios. At the direction of Congress, the Treasury issued the temporary regulations, which provide that the partner's share of recourse liabilities would be determined according to the portion of economic risk of loss for the liability borne by each partner. Temp. Regs. Sec. 1.752-IT(a)(2) provides that a partner's share of nonrecourse liabilities is equal to the sum of (1) the partner's share of partnership minimum gain under Sec. 704(b), (2) any Sec. 704(c) minimum gain allocable to the partner and i3} the partner's share of any additional nonrecourse liabilities allocated m accordance with the partner's profit-sharing percentage. While the temporary regulations were a major departure from the old regulations, the final regulations represent a fine tuning of the temporary regulations. As a result, a Sec. 752 election by a partnership with liabilities subject to the old regulations may result in profound differences in the tax treatment of partnership liabilities. Partnerships with liabilities subject to the old regulations should thoroughly consider the ramifications of a Sec. 752 election, particularly for partnerships that have borrowed from related parties.

While the final regulations generally restate the temporary regulations, there are a number of significant modifications. For instance, if a partner or related party guarantees more than 25% of the total interest on a nonrecourse partnership liability, the final regulations provide that an otherwise nonrecourse liability will be treated as a recourse liability to the extent of the present value of the guaranteed future interest payments. (The temporary regulations had provided a 20% threshold.) Probably more noteworthy is that the final regulations provide a safe harbor; a guarantee of interest for a period not exceeding the lesser of five years or one-third of the loan term will not be subject to reclassification as a recourse obligation.

The final regulations also expand the de minimus ule on the reclassification of nonrecourse liabilities as recourse liabilities to include partner guarantees as well as partner loans (Regs. Sec. 1.759,2(d)). Under the temporary regulations, a partner's nonrecourse loan to a partnership would not be reclassified as recourse if the partner (or related party) owned a 10% or less interest in partnership income, gain, loss, deduction or credit and the loan constituted qualified nonrecourse financing under Sec. 465(b)(6)(determined without regard to the type of activity financed). The final regulations expand this exception to include partner or related-party guarantees of such loans.

The reduced scope of the interest guarantee rules under the final regulations can, in many cases, allow a partnership to avofd the complicated present-value computations (and regular recomputations) otherwise required by Regs. Sec. 1.752-2(e)(2). Partners can also benefit by avoiding undesirable tax basis shifts that may result from treating otherwise nonrecourse debt as recourse to the extent of the partner's guarantee of interest.

The final regulations also differ from the temporary regulations on the valuation of pledged property. Under Regs. Sec. 1.752-2(h)(3), the value of all pledged property is determined only at the time of the pledge. The temporary regulations provided that the value of property with a readily ascertainable fair market value is recomputed from time to time over the life of the loan. Partnerships with partners who have pledged property should consider whether an election to apply the final regulations would be advantageous.

The election to apply the final regulations to all partnership liabilities is made by attaching a statement to the partnership return for the first partnership tax year ending on or after Dec. 28, 1991. Thus, a taxpayer with 1991 calendar year returns extended to October 15 may still have time to make the election. The statement must include the partnership's name, address and taxpayer identification number, and must contain a declaration that the election is being made under Regs. Sec. 1.752-5(b).

From James F. Ruane, CPA, Chicago, Ill.
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Author:Ruane, James F.
Publication:The Tax Adviser
Date:Oct 1, 1992
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