1. C HAPTER 2: P ARTNERSHIP I NTEREST R ECEIVED FOR C ONTRIBUTION OF P ROPERTY

2. P ARTNERSHIP I NTEREST When property is transferred to a partnership in exchange for a partnership interest, generally no gain or loss is recognized. General rule: This is treated as a tax-free exchange. – Contributions to an S corporation in exchange for stock are taxable unless shareholders owning 80 percent or more of the outstanding stock make contributions to the S corporation in the same transaction

3. P ARTNER ’ S AND P ARTNERSHIP ’ S B ASIS The partner has an “exchanged basis” in the partnership interest. Equal to the combined bases of the contributed properties. The partnership takes a “transferred basis” in the contributed property. Equal to the contributing partner’s basis.

4. C ODE 754 E LECTION This election allows the partnership to adjust the basis of its assets to reflect the gain or loss recognized by the contributor-partner on the sale of his or her partnership interest. This avoids recognizing a gain or loss twice (once when the partner sells his or her interest in the partnership and another time when the partnership disposes of the contributed asset.

5. C ODE S EC. 705 B ASIS A DJUSTMENTS The partner’s partnership interest basis is increased by the partner’s share of taxed income. – So, when the partner sells his interest in the partnership, the previously taxed income isn’t taxed again. The partner’s partnership interest basis is also increased by his share of tax-exempt income. Nondeductible non-capitalized expenditures reduce the basis of partnership interest. Deductible losses or expenses reduce the basis of the partnership interest.

6. P ARTNERSHIP B ASIS At formation, the total of the partnership’s basis in its properties (“inside basis”) equals the total of the partners’ bases in their partnership interest (“outside basis”). However, many events can cause inequality between the inside and outside bases.

7. S ALE OF P ARTNERSHIP I NTEREST When a partnership interest is sole (absent a Code Sec. 754 election), the partnership’s inside basis remains unchanged but the outside basis is changed. – Usually the difference between the bases equals the seller’s gain or loss on the sale. If a Code Sec. 754 election is made, equality between the inside and outside basis usually continues.

8. H OLDING P ERIOD A partner must add the holding period of contributed capital and Code Sec. 1231 assets to the holding period of his or her partnership interest (which was received for contributing the assets). The partnership interest received for contributions of other property starts the day after it’s received.

9. D EPRECIATION M ETHODS When depreciable property is contributed in a tax-free exchange, the partnership must use the transferor’s depreciation method and remaining depreciable life. No basis increase is allowed if a partner recognizes gain on a contribution of encumbered property to the partnership.

10. D EPRECIATION M ETHODS C ONT. If there’s a Code Sec. 754 election in effect to the extent that a partner’s net debt relief causes gain to be recognized on the contribution (and the property’s basis in the partnership’s hands is greater than its basis in the transferor’s hands), the increase in basis is treated as a separate asset.

11. C ONTRIBUTIONS OF E NCUMBERED P ROPERTY Both the contributing partner and the other partners should treat the contribution of encumbered property as consisting of 2 steps: – 1) The existence of the debt is ignored and the contributing partner increases his or her basis by the amount of the contributed property’s basis. – 2)The debt is taken into account. Each partner has a deemed cash contribution or distribution. Partners with deemed cash contributions will increase their basis by that amount and partner’s with deemed cash distributions will decrease their basis by that amount.

12. C ONTRIBUTIONS OF E NCUMBERED P ROPERTY C ONT. When encumbered property is contributed to a partnership and the partnership becomes primarily liable for paying the debt, the contributing partner’s non-partnership-related liabilities for which he or she is directly responsible decrease by the amount of such debt. – This is treated as a cash distribution from the partnership. – However, in taking over this liability, the partnership’s indebtedness increases by the same amount. This means that each partner is treated as having made a cash contribution to the partnership in the amount of his or her share in the new debt.

13. C ONTRIBUTING P ROPERTY C REATING A G AIN To determine a partner’s net debt relief: An increase in the partner’s share of debt from the previous year-end to the current year-end is deemed a money contribution. The money contribution is offset against the partner’s debt taken over by the partnership and any net debt relief is deemed money distribution. If this money distribution exceeds his basis in the partnership interest, the excess is gain.

14. E FFECT OF P ARTNERSHIP O PERATIONS ON B ASIS Income and Loss—Taxable and Tax-Exempt A basis increase is necessary when taxable income is earned, otherwise it could be taxed a second time as gain from the sale of the partnership interest when it’s eventually sold. A basis increase is necessary when tax-exempt income is earned to avoid having the tax-exempt income result in increased gain (or reduced loss) on the sale of the partnership interest.

15. E FFECT OF P ARTNERSHIP O PERATIONS ON B ASIS – A partner’s basis must be reduced for his share of the partnership’s losses. Otherwise, otherwise he’ll be allowed a second loss (or reduced gain) on sale of the partnership. If increased loss or reduced gain was allowed on tax-exempt income, then the income would essentially no longer be tax- free. – Under Code Sec. 705(a)(3), a partner’s basis in their partnership interest will also be increased for their share of the excess of depletion over the basis of the property subject to depletion. However, a partner’s basis will not be affected by the production activities deduction they are allowed to take as a result of partnership activities.

16. E FFECT OF P ARTNERSHIP O PERATIONS ON B ASIS Contributions and Distributions – Contributions result in an increased basis. – Distributions result in a decreased basis. Distributions may not make the basis go below zero. – The adjustments to basis are intended to ensure that: 1) A partner’s share of taxable income and deductions is taken into account only once. 2) Nondeductible expenditures and tax-exempt income remain characterized as such. 3) Distributions of previous contributions and previously taxed income are not taxed.

17. E FFECT OF P ARTNERSHIP O PERATIONS ON B ASIS – Determining a partner’s basis in the partnership can be very confusing if not impossible to determine by using past Form 1065s. – Code Sec. 705(b) provides an alternative rule for determining a partner’s basis in his or her partnership interest. The alternative rule initially consists of determining the partner’s basis by reference to the adjusted basis of his or her pro rata share of the partnership property. After making the necessary adjustments, this is his basis. A partner may also determine his or her basis by making certain adjustments to the sum of his or her tax basis capital account and share of the partnership’s liabilities

18. C ONTRIBUTIONS R EQUIRING S PECIAL C ONSIDERATIONS Property Subject to Depreciation Recapture – The depreciation recapture provisions generally require that when recapture property is transferred the potential recapture amount is taxed. – Code Sec. 1245 Gain on Contribution: The amount realized (hypothetical distribution of cash) is divided between Code Sec. 1245 and non-Sec. 1245 property based on the fair market value of recapture property versus other property contributed.

19. C ONTRIBUTIONS R EQUIRING S PECIAL C ONSIDERATIONS Partnership Recognizes Code Sec. 1245 Gain: When the partnership eventually sells the contributed property, it may be required to recapture depreciation deductions previously claimed either before or after the contribution. To the extent the gain on a subsequent sale represents the difference between the fair market value of the Code Sec. 1245 property and the adjusted tax basis at the time of contribution, that gain including the recapture will be allocated to the contributing partner.

20. C ONTRIBUTIONS R EQUIRING S PECIAL C ONSIDERATIONS Accounts Receivable Considered property and may be transferred free of taxation pursuant to Code Sec. 721. The contributor’s basis in the accounts receivable will become the partnership’s transferred basis in the receivables. The partnership will report income if its collections of these receivables exceed their transferred basis.

21. C ONTRIBUTIONS R EQUIRING S PECIAL C ONSIDERATIONS Partner’s Personal Obligations The obligation is treated as a promise to provide funds in the future. It does not constitute a current contribution of property or money within the meaning of Code Sec. 721.

22. C ONTRIBUTIONS R EQUIRING S PECIAL C ONSIDERATIONS Personal Use Property (A partner’s contribution of property which, before the contribution, was not considered investment or business property) – Partnership’s Basis: Takes the lower of the FMV at the time of contribution or the contributing partner’s adjusted basis. Basis for Loss Computations: Lower of FMV or the partner’s basis at the time of contribution. Basis for Gain Computations: Partner’s basis plus or minus adjustments attributable to partnership’s ownership. If using the loss basis produces a gain, or using the gain basis produces a loss, then the partnership will not report a gain or a loss.

23. C ONTRIBUTIONS R EQUIRING S PECIAL C ONSIDERATIONS – Partner’s Basis: The partner’s basis in his partnership interest shouldn’t include the amount by which the contributed property’s basis exceeded its value at the time of contribution. The exchanged basis should be limited to the FMV. When computing a gain, both the partner’s basis in his interest, and the partnership’s basis in its assets, include the contributor’s entire basis. When computing gain on the receipt of money in excess of the partner’s basis in the partnership interest, the exchanged basis should be the carryover basis without reference to the FMV of the contributed property.

24. C ONTRIBUTIONS R EQUIRING S PECIAL C ONSIDERATIONS Suspended Losses – Any losses suspended by Code Secs. 465 or 469 prior to the contribution of the related activity remain with the contributing partner and are not transferred to the partnership. – If the activity produces income in the partnership’s hands, it will be either passive income or “income from a former passive activity” which can be offset by any of the activity’s unused passive activity deductions from a prior year. – All income generated by the activity on the partnership’s hands results in an additional at-risk amount.

25. C HAPTER 9: P ARTNER ’ S S HARE OF P ARTNERSHIP D EBT

26. P ARTNER ’ S S HARE OF D EBT I NCLUDED IN T AX B ASIS : A DJUSTMENTS The partnership must disclose on Schedule K-1 each partner’s share of: 1. Nonrecourse debt other than that considered qualified nonrecourse debt under Code Sec. 465(b)(6). 2. Qualified nonrecourse financing. 3. Each partner’s share of the partnership’s recourse debt. A liability for which any partner or party related to a partner bears the economic risk of loss.

27. P ARTNER ’ S S HARE OF D EBT I NCLUDED IN T AX B ASIS : A DJUSTMENTS C ONT. Code Sec. 752 treats an increase or a decrease in a partner’s share of partnership liabilities as a deemed money contribution or distribution, respectively. Contributions increase a partner’s basis. Distributions decrease a partner’s basis (but not below zero). Distributions in excess of the basis trigger a gain.

28. P ARTNER ’ S S HARE OF D EBT I NCLUDED IN T AX B ASIS : A DJUSTMENTS C ONT. A deemed contribution or distribution will arise only if one or both of the following events occurs: 1. The total partnership debt changes; and/or 2. The method for sharing partnership debt changes. A partner’s share of debt is calculated as of the last day of the partnership year.

29. P ARTNER ’ S S HARE OF D EBT I NCLUDED IN T AX B ASIS : C ONTRIBUTIONS & D ISTRIBUTIONS If the partner assumes the debt or takes the property subject to the debt he or she is treated as having contributed money to the partnership equal to the debt assumed (i.e., the debt encumbering the property). When a partnership assumes a partner’s liability or takes property subject to a partner’s liability in a contribution, the partner is treated as if he or she received a distribution of cash in an amount equal to the amount of the debt transferred.

30. P ARTNER ’ S S HARE OF D EBT I NCLUDED IN T AX B ASIS : C ONTRIBUTIONS & D ISTRIBUTIONS C ONT. Contribution of Encumbered Property – The contribution of encumbered property to a partnership should be analyzed as two separate transactions: 1. The contribution of property by the partner to the partnership, followed by 2. A distribution of cash by the partnership to the partner. – This is equal to the amount of the liability encumbering the property less the contributing partner’s share of the transferred debt.

31. P ARTNER ’ S S HARE OF D EBT I NCLUDED IN T AX B ASIS : C ONTRIBUTIONS & D ISTRIBUTIONS C ONT. The contribution of encumbered property to a partnership alters every partner’s share of the partnership’s liabilities: The liability encumbering the contributed property increases the partnership’s total liabilities, thus increasing each partner’s share of those debts. Distributions of Encumbered Property A partnership distribution of property encumbered by a liability should be analyzed as two transactions:

32. P ARTNER ’ S S HARE OF D EBT I NCLUDED IN T AX B ASIS : C ONTRIBUTIONS & D ISTRIBUTIONS C ONT. 1. The distribution of unencumbered property to the partner, accompanied by 2. The contribution by the recipient-partner of money to the partnership. This is equal to the amount of the liability encumbering the distributed property. The assumption by the partner of partnership debt is treated as a cash contribution to the partnership. As such, it increases the partner’s basis in the partnership interest rather than his or her basis in the distributed property.

33. W HAT IS A “L IABILITY ” FOR P URPOSES OF C ODE S EC. 752?: D EBT VS. E QUITY Many issues involved in determining the validity of a debt are essentially the same as those involved in determining whether the “lender” is really an equity partner. The essential question is whether or not the “lender” was participating in the enterprise as: 1. An entrepreneur providing risk capital, or 2. A creditor seeking a return on capital independent of the success or failure of the venture.

34. W HAT IS A “L IABILITY ” FOR P URPOSES OF C ODE S EC. 752?: D EBT VS. E QUITY C ONT. Debt Factors – The following factors are among those that have been used in determining whether a transaction creates a bona fide “debt: 1. Fixed payment date in the not-too-distant future. 2. Loan is secured by property with a value in excess of the loan principal. 3. The extent to which the loan is subordinated to other liabilities of the business. 4. Return on the loan is fixed and not dependent on profit from the enterprise. 5. Borrower is not too thinly capitalized. 6. Control over daily business decisions is a partner characteristic. 7. Expectation of repayment and presence of security.

35. W HAT IS A “L IABILITY ” FOR P URPOSES OF C ODE S EC. 752?: A DDITIONAL C ODE S EC. 752 R EQUIREMENTS A “liability” is any “obligation” that either: Creates/increases basis in a partnership asset (including cash), Is generated as part of a deduction taken into account in computing the taxable income of the obligor, or Is an expenditure that is not deductible in computing the obligor’s taxable income and is not properly capitalized.

36. W HAT IS A “L IABILITY ” FOR P URPOSES OF C ODE S EC. 752?: A DDITIONAL C ODE S EC. 752 R EQUIREMENTS C ONT. In preparing Form 1065, the partnership will in most instances ignore cash basis accounts payable in calculating partnership debt. Contingent liabilities do not affect basis until they create an asset or are the source of a deduction. A nonrecourse obligation is treated as a “liability” for Code Sec. 752 purposes to the same extent that it is treated as a liability for purposes of determining the basis of property or claiming a deduction.

37. C LASSIFICATION OF P ARTNERSHIP L IABILITIES AS R ECOURSE VS. N ONRECOURSE A partnership liability is deemed a recourse liability to the extent that any partner bears the economic risk of loss for that liability. A nonrecourse loan, in contrast, is one where the lender has no right to demand payment from the borrower in the event of default. – The nonrecourse lender’s only option is to take possession of the property securing the loan. – If the value of the property is not sufficient to satisfy the outstanding debt, the lender has no recourse against the borrower or any other party.

38. C LASSIFICATION OF P ARTNERSHIP L IABILITIES AS R ECOURSE VS. N ONRECOURSE C ONT. Recourse liabilities are shared among the partners in accordance with the manner in which they share the economic risk of loss associated with partnership operations. Nonrecourse liabilities are generally shared in accordance with the way the partners will share in the gain from sale of the property securing the nonrecourse liabilities.

39. P ARTNER ’ S S HARE OF P ARTNERSHIP R ECOURSE D EBT A partner bears the economic risk of loss for a partnership liability only to the extent that the partner: Can be required to make a capital contribution to the partnership Restore a deficit in his or her capital account Pay a creditor directly, or Reimburse another partner for a payment made by such partner to a creditor of the partnership.

40. P ARTNER ’ S S HARE OF P ARTNERSHIP R ECOURSE D EBT C ONT. In determining whether a partner or related party is obligated to make payments to the partnership (or to a creditor or other partner), the following contractual obligations must be considered: 1. Contractual obligations outside the partnership agreement. 2. Obligations to the partnership that are imposed by the partnership agreement. 3. Payment obligations imposed by state law.

41. P ARTNER ’ S S HARE OF P ARTNERSHIP R ECOURSE D EBT C ONT. A partner who has a greater than 10 percent interest in the partnership is deemed to bear the economic risk of loss for any loan that the partner or person related to that partner makes to the partnership, assuming the loan is nonrecourse to the partnership and the other partners.

42. P ARTNER ’ S S HARE OF P ARTNERSHIP R ECOURSE D EBT : C ONSTRUCTIVE L IQUIDATION OF THE P ARTNERSHIP The regulations require the partnership to analyze the consequences that would result from a hypothetical “constructive liquidation”. – A constructive liquidation is a hypothetical situation in which all the partnership’s assets become completely worthless and the partnership is left with no funds available to pay its creditors. – The partnership’s assets are deemed to have been exchanged for no consideration, and the resulting hypothetical losses are allocated among the partners in accordance with their loss-sharing ratios in the partnership agreement.

43. P ARTNER ’ S S HARE OF P ARTNERSHIP R ECOURSE D EBT : C ONSTRUCTIVE L IQUIDATION OF THE P ARTNERSHIP When these hypothetical losses are posted to the partners’ capital accounts, the resulting balances reflect the partners’ potential risk of loss at that moment in time from partnership operations. – Partners with deficit balances in their capital accounts following the hypothetical liquidation would be required to make payments to the partnership. – Those payments serve as the measure of the partners’ individual risks of loss with respect to partnership liabilities.

44. P ARTNER ’ S S HARE OF P ARTNERSHIP R ECOURSE D EBT : C ONSTRUCTIVE L IQUIDATION OF THE P ARTNERSHIP The constructive liquidation test requires an analysis of the partners’ capital balances and resulting obligations under the terms of the partnership agreement in connection with the following hypothetical events: 1. All of the partnership’s liabilities become payable in full; 2. All of the partnership’s assets (except property contributed solely to secure a partnership liability have a zero value; 3. The partnership in fact disposes of all of its assets for no consideration other than the relief of nonrecourse liabilities;

45. P ARTNER ’ S S HARE OF P ARTNERSHIP R ECOURSE D EBT : C ONSTRUCTIVE L IQUIDATION OF THE P ARTNERSHIP 4. All items of partnership gain and are allocated among the partners in accordance with the terms of the partnership agreement; and 5. The partnership liquidates. Distributions and special loss allocations have the effect of shifting debt, and therefore basis, to those partners receiving the distributions or special loss allocations (assuming such partners’ shares of subsequent partnership loss are not affected by the distribution or special allocation).

46. P ARTNER ’ S S HARE OF P ARTNERSHIP R ECOURSE D EBT : N ONRECOURSE L OANS R ECHARACTERIZED AS R ECOURSE Nonrecourse Loans From Partners – Generally speaking, a nonrecourse loan from a partner to the partnership will be recharacterized as a recourse loan allocable entirely to the partner who made the loan. – These rules do not apply if the partner from whom the loan is received owns an interest in each item of partnership income, gain, deduction, loss or credit of 10% or less. – Where a nonrecourse loan from a partner or related person to the partnership “wraps around” an existing nonrecourse loan from an unrelated lender, only the excess portion of the wrap around loan is subject to these provisions.

47. P ARTNER ’ S S HARE OF P ARTNERSHIP R ECOURSE D EBT : N ONRECOURSE L OANS R ECHARACTERIZED AS R ECOURSE C ONT. Reimbursement Rights – A partner’s obligation to pay a partnership liability is reduced to the extent that the partner is entitled to reimbursement from another partner or a person who is related to another partner. Assumed Liability to Pay – The partner who has an obligation in fact discharges the obligation on the constructive liquidation of the partnership, notwithstanding that the partner may not in fact possess sufficient assets to do so.

48. P ARTNER ’ S S HARE OF P ARTNERSHIP R ECOURSE D EBT : N ONRECOURSE L OANS R ECHARACTERIZED AS R ECOURSE C ONT. Plan to Avoid – An obligation will be disregarded if the facts and circumstances indicate a plan to circumvent or avoid such obligation. Tantamount to a Guarantee – If one or more partners or related persons undertake contractual obligations that substantially eliminate a creditor’s risk on an otherwise nonrecourse loan, the arrangement may be considered tantamount to a guarantee and treated for all purposes under the regulations as a guarantee.

49. P ARTNER ’ S S HARE OF P ARTNERSHIP R ECOURSE D EBT : N ONRECOURSE L OANS R ECHARACTERIZED AS R ECOURSE C ONT. Time of Satisfaction – If a payment obligation to a third party is taken into account at its face amount, it must be payable within a reasonable time after the liability becomes due. – An obligation to make a contribution to the partnership must be payable before the later of the end of the year in which the partner’s interest is liquidated or 90 days after the liquidation. Otherwise it is recognized only to the extent of its value. The value equals the face value if the interest rate is equal to the applicable federal rate under Code Sec. 1274(d). Otherwise it’s discounted to the present value as calculated under Code Sec. 1274(b).

50. P ARTNER ’ S S HARE OF P ARTNERSHIP R ECOURSE D EBT : N ONRECOURSE L OANS R ECHARACTERIZED AS R ECOURSE C ONT. Assumption A partner who assumes responsibility for a partnership debt is considered liable if: The assuming partner is subject to personal liability with respect to such liability; and In case of assumption by the partner, the creditor is aware of the assumption and can directly enforce the partner’s obligation.

51. P ARTNER ’ S S HARE OF P ARTNERSHIP R ECOURSE D EBT : N ONRECOURSE L OANS R ECHARACTERIZED AS R ECOURSE C ONT. Guarantees – The partners who bear the economic risk of loss are deemed to bear the risk of loss constituting the obligation. The person with the primary liability will be considered the party with the risk of loss. – The guarantor of a partnership recourse liability generally has a “reimbursement right” from the partnership’s general partners and is therefore not the person with the ultimate risk of loss. – The guarantor of a nonrecourse liability does not have the right to reimbursement from the other partners and will be treated as bearing 100% of the risk for the guaranteed nonrecourse liability. – This rule does not apply unless the guarantor’s interest in all items of partnership income, gain, loss, deduction, or credit exceeds 10 percent.

52. P ARTNER ’ S S HARE OF P ARTNERSHIP R ECOURSE D EBT : N ONRECOURSE L OANS R ECHARACTERIZED AS R ECOURSE C ONT. Interest Guarantees – If: A liability would otherwise be a nonrecourse liability except that one or more partners are obligated to pay more than 25 percent of the total interest that will accrue on the liability if the partnership fails to pay such interest, and It is “ reasonable” to expect that the guarantor will be required to pay “ substantially all ” of the future interest if the partnership fails to do so, – Then: the guarantor partners will be treated as having an economic risk of loss with respect to the liability to the extent of the present value of the guaranteed interest payments, with the balance of the liability being treated as nonrecourse.

53. P ARTNER ’ S S HARE OF P ARTNERSHIP R ECOURSE D EBT : N ONRECOURSE L OANS R ECHARACTERIZED AS R ECOURSE C ONT. It is “reasonable” to expect that the guarantor will be required to pay substantially all of the guaranteed interest if, upon default by the partnership, the lender can enforce the interest guaranty without foreclosing on the property and extinguishing the underlying debt. The partner’s risk of loss is deemed to be equal to the present value of the unpaid guaranteed interest, valued as of the date of determination. The interest guarantee rules do not apply if the guaranty is for a period not greater than the lesser of five years or one-third of the period of the loan.

54. P ARTNER ’ S S HARE OF P ARTNERSHIP N ONRECOURSE D EBT Nonrecourse liabilities are those liabilities for which no partner (or related person ) bears personal risk of loss. If the loan is obtained from a partner then the lender, who is a partner in the partnership, bears personal risk of loss and the liability will be treated as a recourse loan for purposes of Code Sec. 752. The debt is included in the basis.

55. P ARTNER ’ S S HARE OF P ARTNERSHIP N ONRECOURSE D EBT : A LLOCATED BY P ARTNERS ’ P ROFIT I NTEREST Partners’ interests in partnership profits are divided into three categories: 1. “Book” minimum gain 2. Code Sec. 704(c) minimum gain 3. Other profits A partner’s share of partnership nonrecourse liabilities equals the sum of: 1. The partner’s share of “book minimum gain determined in accordance with the rules of Code Sec. 704(b); 2. The amount of taxable gain that would be allocated to the partner under Code Sec. 704(c) if the partnership disposed of all partnership property subject to one or more nonrecourse liabilities of the partnership in full satisfaction of its liabilities and for no other consideration; and 3. The partner’s share of the excess nonrecourse liabilities of the partnership as determined in accordance with the partner’s share of partnership profits.

56. P ARTNER ’ S S HARE OF P ARTNERSHIP N ONRECOURSE D EBT : A LLOCATED BY P ARTNERS ’ P ROFIT I NTEREST C ONT. There are two alternatives to the allocation in step 3: – They expressly give the partnership the option to allocate nonrecourse liabilities in excess of the two categories of minimum gain ( i.e., excess nonrecourse liabilities) “in accordance with the manner in which it is reasonably expected that the deductions attributable to those nonrecourse liabilities will be allocated”. – The partnership may first allocate an excess nonrecourse liability to a partner up to the amount of built-in gain that is allocable to the partner on section 704(c) property where such property is subject to the nonrecourse liability to the extent that such built-in gain exceeds the gain described in step 2 above.

57. P ARTNER ’ S S HARE OF P ARTNERSHIP N ONRECOURSE D EBT : M INIMUM G AIN Partnership “minimum gain” is the amount of gain which would be recognized by the partnership if it surrendered the property to the nonrecourse lender in satisfaction of the outstanding balance of the debt. The partnership will realize gain in an amount equal to the excess of the outstanding balance of the loan over the book value (adjusted for depreciation deductions) of the property. – The partnership could realize more gain on disposition of the property but never less.

58. P ARTNER ’ S S HARE OF P ARTNERSHIP N ONRECOURSE D EBT : M INIMUM G AIN C ONT. Under the section 704(b) regulations, the existence of partnership minimum gain allows partners’ capital accounts to fall below zero even in the absence of any requirement on their parts to make additional capital contributions to “restore” these deficit balances. – As long as the deficits do not exceed the partners’ shares of partnership minimum gain, any deficit in their capital accounts can be made up with an allocation of minimum gain. – This increases the partners’ taxable income.

59. P ARTNER ’ S S HARE OF P ARTNERSHIP N ONRECOURSE D EBT : C ODE S EC. 704( C ) Code Sec. 704(c) minimum gain arises when a partnership owns property encumbered by nonrecourse debt which has a book value in excess of its tax basis. The total amount of “minimum gain” which would be recognized by the partnership in the event of default and foreclosure by the nonrecourse lender is equal to the excess of the principal amount of the note over the tax basis of the property.

60. P ARTNER ’ S S HARE OF P ARTNERSHIP N ONRECOURSE D EBT : C ODE S EC. 704( C ) C ONT. The total minimum gain is divided into two parts: 1. “Book” minimum gain is equal to the excess of the nonrecourse debt balance over the book value of the property. 2. The remainder of the minimum gain will be allocated under Code Sec.704(c). It is possible to have Code Sec. 704(c) minimum gain, but no “book” minimum gain. Similarly, it is possible to have “book minimum gain, but no Code Sec. 704(c) minimum gain.

61. P ARTNER ’ S S HARE OF P ARTNERSHIP N ONRECOURSE D EBT : “E XCESS ” N ONRECOURSE L IABILITIES Partnership nonrecourse liabilities in excess of the partnership’s book and Code Sec. 704(c) minimum gain ( i.e., “excess” liabilities) are allocated in accordance with the partners’ interests in general partnership profits. A partnership may choose to allocate excess nonrecourse liabilities first to the contributing partner to the extent of built-in gain allocable to that partner under Code Sec. 704(c) which exceeds the amount of Code Sec. 704(c) minimum gain as determined under step 2. Alternatively, it may choose to allocate excess nonrecourse liabilities among the partners in accordance with the manner in which it expects to allocate depreciation deductions attributable to the properties encumbered by the nonrecourse liabilities.

62. P ARTNER ’ S S HARE OF P ARTNERSHIP N ONRECOURSE D EBT : “E XCESS ” N ONRECOURSE L IABILITIES C ONT. A partnership is not required to use the same method to allocate its excess nonrecourse deductions every year. Nonrecourse liabilities are generally allocated on a liability-by-liability basis, so that accurate measures of book and tax minimum gain, and the partners’ interests therein, can be determined

63. P ARTNER ’ S S HARE OF P ARTNERSHIP N ONRECOURSE D EBT : M ULTIPLE P ROPERTIES When a single nonrecourse loan is secured by multiple properties, measurement of minimum gain is problematic. Partnerships may use any “reasonable” method to apportion the liability among the different properties securing it, so long as the apportionment does not result in the allocation of debt to any property in excess of its fair market value.

64. P ARTNER ’ S S HARE OF P ARTNERSHIP N ONRECOURSE D EBT : M ULTIPLE P ROPERTIES C ONT. Once the liability has been allocated, it may not be reallocated using a different method. However, if a property to which a portion of the nonrecourse liability has been allocated subsequently becomes no longer subject to the liability, the portion of the nonrecourse debt allocated to that property must be reallocated to the other properties still subject to that debt. Where the outstanding principal balance of the liability is reduced, the reduction must be allocated among multiple properties in the same proportion as the liability was allocated to those properties.