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Partnership liabilities.

Final regulations (TD 9207) define the term "liability" under Sec. 752 and prescribe rules to prevent taxpayers from manipulating the liability rules to create artificial losses when a partnership assumes a partner's obligations.

New classes of liabilities: Regs. Sec. 1.752-1(a)(4)(i) describes two types of liabilities: "[section]1.752-1 liabilities" and "[section]1.752-7 liabilities." An obligation is a "[section]51.752-1 liability" to the extent it:

* Creates or increases the basis of any of the obligor's assets, including cash;

* Gives rise to an immediate deduction to the obligor; or

* Gives rise to an expense that is not deductible in computing the obligor's taxable income and is not properly chargeable to capital account.

All obligations that do not meet the definition of Regs. Sec. 1.752-1 obligations are Regs. Sec. 1.752-7 liabilities. An "obligation" can arise under a contract, debt, tort, pension, short sale or derivative financial instrument or be any other type of obligation, according to Regs. Sec. 1.7521(a)(4)(ii).

A partner must immediately reduce his or her basis in the partnership when the partner transfers a R.egs. Sec. 1.752-1 liability and the partnership assumes it. Regs. Sec. 1.752-7 liabilities do not result in an immediate basis reduction.

Regs. Sec. 1.752-7 liabilities: Traditional liabilities (such as mortgages) are described in Regs. Sec. 1.752-1. Regs. Sec. 1.752-7 describes liabilities that have not traditionally been treated as liabilities under the partnership rules, including those not included in the historic definition under Rev. Rul. 88-77. This category would include derivatives such as options and other contingent obligations.

Obligations that qualify as liabilities under Regs. Sec. 1.752-7 are treated significantly differently from Kegs. Sec. 1.752-1 liabilities, because they do not result in an immediate basis reduction. Instead, basis reduction is delayed until a triggering or "separation" event occurs, such as:

1. A disposition or partial disposition of the partnership interest; 2. A liquidation of the partnership interest by the partnership; or 3. Another partner's assumption of the liability.

Additionally, when the partnership satisfies the obligation or when the obligation otherwise becomes fixed (when economic performance occurs), the deduction related to the assumed liability is allocated to the contributing partner under Sec. 704(c) principles. In effect, the liability assumed by the partnership is treated as built-in loss (BIL) property; the BIL equals the amount of the liability at the time of contribution. This treatment is designed to pre vent the acceleration of losses when the liability is assumed while, at the same time, allowing the partner to claim the deduction when it is passed through by the partnership.

The Regs. Sec. 1.752-7 liability rules include an exception for transactions in which a partner contributes to the partnership the trade or business with which the liability is associated (similar to the Sec. 358(h) (2)(A) exception for corporations). There is also a de minimis exception for situations in which the liabilities assumed (i.e., the remaining BIL attributable to Kegs. Sec. 1.752-7 liabilities under Sec. 704(c)) are smaller than the lesser of $1 million or 10% of the gross value of partnership assets immediately before the triggering event. There is no exception for transactions in which the partner contributes substantially all of the assets associated with the liability.
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Title Annotation:rules to prevent taxpayers from manipulating the liability rules
Author:Laffie, Lesli S.
Publication:The Tax Adviser
Date:Aug 1, 2005
Previous Article:Schedule M-3 revisions.
Next Article:Implied agreement triggered estate inclusion of FLP assets.

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