LB&I Concept Unit - IRS tax forms

LB&I Concept Unit

Unit Name

Determining Liability Allocations

Primary UIL Code 752.00-00 Treatment of Certain Liabilities

Library Level Knowledge Base Shelf Book Chapter

Title Partnerships General Concepts Partnership Liabilities Liability Allocations

Document Control Number (DCN) PAR-C-004

Date of Last Update

09/15/20

Note: This document is not an official pronouncement of law, and cannot be used, cited or relied upon as such. Further, this document may not contain a comprehensive discussion of all pertinent issues or law or the IRS's interpretation of current law.

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Table of Contents

General Overview Detailed Explanation of the Concept Examples of the Concept Index of Referenced Resources Training and Additional Resources Glossary of Terms and Acronyms Index of Related Practice Units

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General Overview

Determining Liability Allocations

The concept of liability allocation is covered under IRC 752 and the related regulations.

Partnership liability allocations have a major impact on the computation of a partner's basis in his partnership interest (outside basis). A partner must calculate outside basis in many situations, including when he receives a routine distribution of money, when he is allocated a loss, when the partnership redeems his interest in a liquidating distribution, or when he sells his interest in the partnership.

The partnership reports each partner's share of partnership liabilities at the end of the year on Schedule K-1 Part II, Section K. Liabilities are reported on Schedule K-1 in three categories: recourse, nonrecourse, and qualified nonrecourse. Qualified nonrecourse financing is nonrecourse financing borrowed for use in an activity of holding real property and is primarily relevant for purposes of the at-risk rules (which are beyond the scope of this practice unit). The subchapter K rules for allocating liabilities to partners distinguish only between nonrecourse and recourse debts.

An increase in a partner's share of partnership liabilities is treated as a contribution of money by the partner to the partnership and thus increases his outside basis. A decrease in a partner's share of partnership liabilities is treated as a distribution of money to the partner and thus decreases his outside basis. IRC 752(a) and (b).

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General Overview (cont'd)

Determining Liability Allocations

Not all liabilities shown on a partnership's tax return balance sheet (Form 1065, Schedule L) are recognized as liabilities for tax purposes.

Treas. Reg. 1.752-1 defines partnership liabilities. In general, for a liability to be recognized for tax purposes, it must (1) create or increase the basis of any of the partnership's assets, (2) give rise to a tax deduction, or (3) give rise to an expense not properly deductible or chargeable to capital. With some liabilities such as environmental obligations, tort obligations, contract obligations, and pension obligations, the obligation might be recognized for Generally Accepted Accounting Principles (GAAP) purposes but do not meet the tests set forth in Treas. Reg. 1.752-1 and do not affect basis for tax purposes until satisfied. For additional information, see the Practice Unit on Recourse vs. Nonrecourse Liabilities.

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Detailed Explanation of the Concept

Determining Liability Allocations

Recourse and Nonrecourse Liability Allocations

Analysis

Resources

Allocating Recourse Liabilities

Publication 541 and Treas. Reg 1.752-2 discuss the allocation rules for recourse liabilities. Treas. Reg. 1.752-2

Pub. 541 A partnership liability is a recourse liability to the extent that any partner or a related person has an economic risk of loss for that liability. A partner's share of a recourse liability equals his economic risk of loss for that liability. A partner has an economic risk of loss if that partner or a related person would be obligated, whether by agreement or law, to make a payment to the creditor or a contribution to the partnership with respect to the liability if the partnership were constructively liquidated. A partner who is the creditor for a liability that would otherwise be a nonrecourse liability of the partnership has an economic risk of loss in that liability.

In sum, a partner bears the economic risk of loss if the partner or related person (1) has a payment obligation, Treas. Reg 1.752-2(b) (except for 1.752-2(d)(2)); (2) is a lender to the partnership, 1.752-2(c) (except for 1.752-2(d)(1)); (3) guarantees payment of interest, 1.7522(e); or (4) pledges property as security for a partnership liability, 1.752-2(h).

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