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New basis calculations for partners under Section 752.

A partner's basis in a partnership is increased by the money and property that the partner contributes to the partnership. Section 752 also allows a basis increase when a partner assumes a partnership liability. The amount of the increase depends upon the classification of the liability. Under the old regulations, recourse liabilities were defined as liabilities for which one or more of the partners were personally liable. The partners increased their basis according to their loss sharing ratios. Since limited partners were not liable for partnership debts beyond their contributions to the partnership, they were denied a basis increase for recourse liabilities unless they were required to contribute additional capital to the partnership. This created several inequities. If a limited partner was required to make contributions to one or more of the partners rather than to the partnership itself, a basis increase was denied.(1) In addition, if a limited partner guaranteed a nonrecourse liability and the liability was reclassified as recourse, the limited partners lost the basis increase unless there was a requirement to contribute additional capital. To get around this classification, courts allocated basis increases on an "ultimate liability test." The courts looked to the terms of the liability and asked who was ultimately liable.(2) If a liability was classified as a nonrecourse loan, a partner's basis was increased by the profit sharing ratio. Since limited partners were not restricted on their share of profits, they received basis increases for nonrecourse loans without further qualifications.

Under the new regulations, the amount of a partner's basis increase still depends on the classification of the loan as recourse or nonrecourse. However, the regulations have redefined recourse loans. While partners are still allocated recourse loans according to loss sharing ratios, the new regulations look beyond the ratios to determine who actually bears the economic risk of loss. If a loan is classified as a nonrecourse loan, it is still allocated according to profit sharing ratios. But once again, the new regulations look further and make the allocations based on allocations of minimum gains and gains allocated under Section 704(c). While Section 752 remains the same, the regulations have radically changed the way a partner's basis is determined when the partner assumes a partnership liability.

Recourse Loans Defined

The new regulations borrow heavily from case law and classify recourse and nonrecourse liabilities based on the concept of economic risk of loss. A liability is a recourse liability to the extent that any partner or related person bears the economic risk of loss. A liability is a nonrecourse liability to the extent that no partner or related person bears the economic risk of loss.(3) A related person consists of the following:

1. A member of the partner's family as the family is described in Section 267(b). However, brothers and sisters are excluded from the definition of family member for purposes of Section 752.

2. A person owning directly or indirectly 80% or more of the capital or profits interest in a partnership.

3. Partnerships in which the same persons own, directly or indirectly 80% or more of the capital or profits interests.(4)

Example: Adam, Barbara and Charlie form the ABC partnership. Each partner contributes $1,000. Adam and Barbara want to loan money to ABC and have the loan treated as a nonrecourse loan. Adam and Barbara form the AB partnership with each contributing $50,000 with losses shared equally. The AB partnership loans $100,000 to the ABC partnership. Under these facts and circumstances, Adam and Barbara bear the economic risk of loss with respect to the loan equally based on their share of losses in the AB partnership.(5)

A person assumes a partnership liability only to the extent that:

1. The person assuming the liability is personally obligated to pay the liability; and

2. The person to whom the liability is owed knows of the assumption and can directly enforce the obligation for payment.

3. No other partner or related person would bear the economic risk of loss for the liability immediately after the assumption.(6)

Note: Under the new regulations, it does not matter whether the obligation to pay rests with the partner or the partnership. However, the lender must know that a partner or related person has assumed the loan.

Allocation of Recourse Liabilities

A partner's share of a recourse liability equals the portion of the liability for which a partner or a related person bears the economic risk of loss.(7)

Obligation to Pay

There are several ways to show economic risk of loss. The first and most obvious way to show economic risk of loss is to be obligated to make payments on the loan. In measuring this obligation, it is assumed that the partnership liquidates. According to the terms of this constructive liquidation, it is further assumed that:

1. All of the partnership's liabilities become payable in full;

2. With the exception of property contributed to secure a partnership liability, all of the partnership's assets, including cash, have a zero value;

3. The partnership disposes of all of its property in a taxable transaction for no consideration except for relief from a liability where the creditor's right to repayment is limited solely to one or more partnership assets;

4. All items of income, gain deduction and loss are allocated among the partners; and

5. The partnership liquidates.(8)

In computing the gain or loss from the "deemed disposition," it is assumed the creditor's right to repayment is limited to one or more of the partnership's assets. Gain or loss is the difference between this right of repayment and the adjusted basis of the asset. A loss is recognized equal to the remaining tax basis of the partnership assets of all partnership property not taken into account in the regulations.(9) |Reg. 1.752-2(b)(2)~

The partner's obligation equals the amount that the partner or related person would have to pay without seeking contribution from another partner or person related to another partner.

Note: In determining whether or not a partner is allowed a basis increase, the relevant question is "who, if anyone, will ultimately be obligated to pay the partnership's recourse obligations if the partnership is unable to do so."

Example: Albert and Betty are partners in the AB partnership. Both contribute $100,000 in cash. The partnership purchases an office building for $1,000,000, using the $200,000 contribution and obtaining a note of $800,000. The partnership agreement provides that all items are allocated equally except that tax losses are specially allocated 90% to Albert and 10% to Betty. Capital accounts are properly maintained and deficits must be restored. In a constructive liquidation, the $800,000 note becomes payable. All of the partnership's assets are considered worthless. Capital accounts are as follows:
 Albert Betty
Beg. Bal. $100,000 $100,000
Loss (900,000) (100,000)
End. Bal $(800,000) $0

The liability is classified as a recourse loan and allocated to Albert because he is the one who bears the economic risk of loss by contributing $800,000 to make up the deficit in his account.(10) |Reg. 1.752-2(f) example 1~

If property is contributed that is subject to a recourse liability and the contributing partner remains liable on the note and cannot seek contribution from other partners, the partner's basis in the partnership interest equals the adjusted of the property contributed without any reduction for liabilities. This is a departure from the old regulations that mandated a basis decrease based on the loss sharing ratio. On the other hand, if property is contributed that is subject to a recourse liability and the contribution shifts the risk of loss to the other partners, the contributing partner will have a basis reduction based on the amount of risk shifted to the other partners.

Note: This is the ultimate liability test mentioned in case law. This ultimate liability is further determined by taking into account all statutory and contractual rights regarding the partnership liability. This includes contractual obligations outside the partnership such as guarantees, indemnifications to creditors, to other partners and to the partnership itself. It includes obligations under the partnership agreement as well as obligations under applicable state law. If there are contingencies that make it unlikely that an obligation will be discharged, the obligation is disregarded until the contingency is removed. Finally, in determining the extent to which an obligation exists, it is assumed that all partners and related persons who have obligations to make payments, make the payments irrespective of their actual net worth.(11)

Partner or Related Person as Lender

Second, the partner also bears the economic risk of loss to the extent that the partner or a related person makes a nonrecourse loan (or acquires an interest in a nonrecourse loan) and the risk of loss in not borne by another partner. If a liability is owed to a partner or related party and the liability is wrapped around a nonrecourse note encumbering partnership property that is owed to another person, the partnership liability will be treated as two separate liabilities. The portion of the partnership liability corresponding to the wrapped debt is treated as a liability owed to another person.(12)

Example: Irma purchases real estate from an unrelated seller for $10,000 in cash and gives a $9,000 purchase money mortgage note for which Irma is not personally liable. When the property is worth $15,000, Irma sells it to the MLI partnership in which Irma is a general partner. The partnership pays for the property by giving a $15,000 mortgage note on which neither the partnership nor any other partner is liable. The $15,000 is a wrapped debt that includes a $9,000 obligation to the original seller. The liability is a recourse note to the extent of $6,000 and is allocated to Irma because she bears the economic risk of loss. The remaining $9,000 is classified as a nonrecourse note.(13)

De Minimis Exceptions

However, if a partner or related person makes a loan to a partnership and for every year that the partner is a partner, the partner has an interest in each item of partnership gain, income, loss or deduction that was 10% or less, the loan will not be counted as a partnership obligation. Similarly, do not count an obligation of a partner whose interest in partnership items is 10% or less if the partner guarantees a debt of the partnership that would otherwise qualify as a nonrecourse loan.(14)

Interest Guarantee

Sometimes, a partner or related person does not have a personal obligation towards the principal of a loan, but does guarantee the interest. If one of more partners or related persons have guaranteed more than 25% of the total interest that will accrue on a partnership nonrecourse liability over its remaining term and it is likely that the guarantor will be required to pay substantially all of the guaranteed future interest if the partnership fails to do so, the liability is treated as two separate loans. The partners or related persons who have guaranteed the interest will be treated as being economically at risk to the extent of the present value of the guaranteed future interest. The rest of the principal constitutes a nonrecourse liability.

Example: On January 2, 1992, a partnership obtains a $4,000,000 loan secured by a shopping center owned by the partnership. Neither the partnership nor any partner has personal liability for the loan. Interest is 15% per year, payable annually on December 31 of each year. The principal is due in 15 years. Paula guarantees 50% of the interest payments. The guarantee can be enforced without first foreclosing on the property. When the partnership obtains the loan, the present value of the future interest is $3,508,422 and the present value of the principal is $491,578. If tested on that date, the loan is treated as a recourse liability to the extent of $1,754,211 (half of the present value of the interest). All of the loan is allocated to Paula because she bears the economic risk of loss. The remainder of the present value $2,245,789 ($1,754,211 + $491,578) is treated as a nonrecourse loan.(15)

Note: This rule applies only if the guarantors are required to pay substantially all of the guaranteed future interest. This rule continues to apply after the point at which the amount of the guaranteed interest that will accrue is less than 25% of the total interest that will accrue on the liability.

In computing the present value of the guaranteed interest, use a discount rate equal to the interest rate stated in the loan documents. If the loan documents contain a variable rate, based on the value of an objective index, assume the interest used on the date of computation remains constant over the term of the loan. Examples of an objective index include the prime rate of a designated financial institution and the London Interbank Offered Rate. If the interest is imputed under Section 283 or 1274, use the applicable federal rate compounded semi-annually.

Special Rules: Do not use the interest guarantee if the guarantee is for a period that does not exceed the lesser of five years or one-third of the term of the loan. In addition do not count the guarantee of a partner or related person if the interest of the partner in partnership items is 10% or less.(16)

Time-Value of Money

In computing the obligation to make payments on a loan, consider the time value of money. If a payment for a partnership obligation is not required to be satisfied within a reasonable time after the liability becomes due, or if the obligation to make additional contributions is not required to be satisfied before the latter of:

1. The end of the year in which the partner's interest is liquidated; or

2. Ninety (90) days after liquidation, the obligation is recognized only to the extent of the obligation.

The value of a payment that is not required to be made within a reasonable period equals the entire principal balance only if the obligation has an interest rate that is equal to or greater than the applicable federal rate under Section 1274(d). If the interest is less than the applicable federal rate, the obligation must be discounted to its present value of all payments due from the partner or related person.(17)

Note: If an obligation may be satisfied with a promissory note, the obligation is not considered to be satisfied unless the promissory note is readily tradeable on an established securities market.(18)

Example: Mary and Jay are partners in the MJ partnership. Mary is the general partner and Jay is a limited partner. Each contribute $10,000 to the partnership which the partnership uses to purchase property costing $90,000 from an unrelated seller. The partnership issues a $70,000 note for the balance of the purchase price. The partnership agreement states that profits and losses are allocated equally and both partners are required to restore deficits. However, Mary must restore her deficit within 90 days of liquidation, while Jay may wait for two years before restoring his deficit. Upon a hypothetical liquidation, capital accounts are as follows:
 Mary Jay
Beg Bal $ 10,000 $ 10,000
Loss ($ 45,000) ($ 45,000)
End Bal ($ 35,000) ($ 35,000)

Jay's obligation to make a payment is recognized only to the extent of the fair market value of the obligation at the time of liquidation. If Jay is not required to pay interest, use the applicable Federal rate. Assuming that this rate is 10% compounded semiannually, the fair market value of Jay's obligation is $28,795. As a result, Jay bears the risk of loss only on this amount and Mary, as the general partner, bears the economic risk of loss on the rest ($70,000 - $28,795 = $41,205).(19)

Providing Property as Security

A partner or related person is considered to be economically at risk to the extent that property is pledged as security for the debt. If property is pledged indirectly by contributing it to the partnership to secure the liability, the contributed property is counted as a pledge only if substantially all of the items of income, gain, loss and deduction from the pledged property are allocated to the contributing partner and the allocation is greater than the partner's share of other significant partnership items. In addition if the contributed property is a promissory note, the note is not counted as a pledge unless the note is readily tradeable on an established securities market.(20)

Important Point: The value of the pledge is limited to the fair market value of the property on the date it is contributed.

Warning: To avoid abuse, an obligation is disregarded if there is an arrangement between the parties to eliminate a risk of loss or to create the appearance of an economic risk of loss when none exists. This rule is applied using all of the facts and circumstances of the arrangement.(21)

Example: The Eagle corporation and Frank form the EF Partnership. Eagle contributes $20,000 and Frank contributes $80,000. Both are obligated to restore deficits their capital accounts. The partnership agreement allocates 20% of partnership losses to Eagle and 80% to Frank. The partnership buys property for $250,000, paying $100,000 in cash and giving a $150,000 note for the balance. Eagle is a subsidiary of a consolidated group with capital limited to $20,000. These facts indicate a plan on the part of Eagle to avoid Eagle's obligation to make contributions to the partnership. As a result, the $150,000 loan is treated as a recourse loan that is allocated entirely to Frank.(22)

Nonrecourse Liabilities

A nonrecourse liability is one in which no partner or related person is personally liable. As a result, no one actually bears the economic risk of loss. However, some type of economic risk exists under the concept of minimum gain. Minimum gain equals the amount of gain a partner would recognize if the property were sold for the loan value less the adjusted basis. Economic risk exists to the extent of gain allocated under Section 704(c). This section states that the partner who contributed appreciated property is allocated this built in appreciation when the property is sold. Therefore, a partner's share of the nonrecourse liabilities equals the sum of:

1. The partner's share of minimum gain;

2. The amount of Section 704(c) gain; and

3. The partner's share of excess liabilities (those not covered by categories 1 and 2) are allocated in accordance with the partner's share in partnership profits.(23)

Key Point: The success of an allocation of nonrecourse liabilities depends upon maintaining proper capital accounts.

Example: Bill and Nancy are partners in the BN partnership. The partnership purchases depreciable property for $1,000 by issuing a nonrecourse note. No principal payments are due for a year. The partnership agreement provides that all items in income, gain, loss and deduction are allocated equally. At the end of the year, the partnership claims a $200 depreciation deduction on the property. The adjusted basis of the property is now $800. If the property were sold for its loan balance of $1,000 the partnership would recognize a gain of $200. According to the partnership agreement, Bill and Nancy would each be allocated $100 of the minimum gain. The remaining $800 of the note would be allocated equally between Bill and Nancy as this is the method in which profits are allocated. As a result, Bill and Nancy would each be allocated $500 of the nonrecourse loan.(24)

Warning: A partner's interest in partnership profits is determined by taking into account all facts and circumstances relating to the economic arrangements of the partners. This arrangement may be found in the partnership agreement. Alternatively, it may be found in the manner in which it is reasonably expected that the deductions attributed to the property will be allocated.

Note: Excess nonrecourse allocation are not required to be allocated under the same method each year.

Example: Assume the same facts as in the above example. However, all of the depreciation is allocated to Bill. Since all of the deductions are allocated to Bill, all of the minimum gain is allocated to Bill. In addition, it is reasonable to assume that any other profits attributable to the property will be allocated to Bill. As a result, Bill is allocated the entire $1,000 nonrecourse liability.(25)

Application Date

Note: The new regulations apply to any liability incurred or assumed by a partnership on or after December 28, 1991. The new regulations do not apply to loans assumed or incurred on or after December 28, 1991, if there was a binding contract regarding the loan prior to December 28 and at all times thereafter.

If the partnership wants the regulations to apply to a loan assumed or incurred before December 28, 1991, the partnership must so elect. The election is made for the first taxable year of the partnership ending on or after December 28, 1991. The election is made by providing a written statement containing the following information:

1. The name, address and taxpayer identification of the partnership making the election; and

2. A declaration that the election is being made pursuant to Reg. 1.752-5(b)

Key Point: If a partnership terminates under Section 708(b)(1)(B) (a sale or exchange of 50% or more of the capital and profits in the partnership), the liabilities incurred prior to termination will not be considered to be incurred or assumed on the date of termination. In other words, a termination of a partnership under Section 708(b)(1)(B) will not cause old liabilities to become subject to the new regulations.(26)


The statute that determines basis increases and decreases for partnership interests when liabilities are involved remains the same. However, the mechanics of the basis increase and decrease are changed. Look past the profit and loss sharing ratios and determine who will ultimately bear the economic risk of loss. Use all the facts and circumstances in making this determination. Examine the partnership agreement, loan provisions and any guarantee provisions with respect to the loan. Do not ignore any provisions in state law. The new regulations are more subjective than the old regulations.


1 Rev. Rul. 69-223, 1969-1 C.B. 184; and Ina Block, 41 TCM 546 (1980).

2 See. Abramson v. Commissioner, 86 TC 360 (1986); Smith v. Commissioner, 84 TC 889 (1985);

3 Reg. 1.752-1(a).

4 Reg. 1.752-4(b).

5 Reg. 1752-4(b)(2)(C).

6 Reg. 1.752-1(d).

7 Reg. 1.752-2(a).

8 Reg. 1.752-2(b)(2).

9 Reg. 1.752-2(b)(2).

10 Reg. 1.752-2(f) example 1.

11 Reg. 1.752-2(b)(6).

12 Reg. 1.752-2(c).

13 Reg. 1.752-2(f) example 6.

14 Reg. 1.752-2(d).

15 Reg. 1.752-2(f) example 7.

16 Reg. 1.752-2(e).

17 Reg. 1.752-(g)(1) and (2).

18 Reg. 1.752-2(g)(3).

19 Reg. 1.752-2(g)(4).

20 Reg. 1.752-2(h).

21 Reg. 1.752-2(j).

22 Reg. 1.752-2(j)(4).

23 Reg. 1.752-3(a).

24 Reg. 1.752-3(b) example 1.

25 Reg. 1.752-3(b) example 2.

26 Reg. 1.752-5(c).

M. Jill Martin, CPA, JD, LLM, is a professor of accounting at Georgia Southern University in Statesboro, Georgia. She received her JD and LLM degrees in taxation from Emory University. She is a member of the State Bar of Georgia and the Georgia Society of CPAs. She has published in several professional accounting journals.
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Author:Martin, M. Jill
Publication:The National Public Accountant
Date:Nov 1, 1992
Previous Article:Valuation factors regarding deprivation analyses.
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