The IRS has finalized proposed rules from 2013 that address the allocation of recourse liabilities among partners and the related-party rules. The final regulations adopt the proposed regs with modifications. (TD 10014, 12/02/2024)
Background.
Under the current regs (existing regs §§1.752-1 through 1.752-3), a partnership liability is recourse to the extent that a partner or related person bears the economic risk of loss (EROL). A partnership liability is nonrecourse when no partner or related person bears the EROL.
2013 proposed regs.
The IRS 2013 proposed regs provided guidance as to when and to what extent a partner would be treated as bearing the EROL for a partnership liability when multiple partners had an EROL for the same partnership liability (“overlapping EROL”). The 2013 regs also provided guidance on when a partner (1) has a payment obligation for a partnership liability or (2) makes a nonrecourse loan to the partnership (and no other partner had an EROL for that liability) and is related to another partner in the partnership. (Preamble to Prop Reg REG-136984-12)
Final regs modify 2013 proposals.
The final regs modified the proposed regs in response to certain comments the IRS received about the proposals. For example, the final regulations add a sentence to Reg §1.704-2(k)(5) to clarify that an Upper-Tier Partnership (UTP) has the EROL for an Lower-Tier Partnership (LTP)’s liability that is treated as the UTP’s liability under Reg §1.752-4(a). Therefore, partners’ nonrecourse deductions attributable to the LTP’s liability are allocated to the UTP under Reg §1.704-2(i).
The final regulations also correct the proposed regulations by listing in one section of the regulations all the situations under Reg §1.752-2 in which a person directly bears the EROL. A person directly bears the EROL if that person, and not a related person, meets the requirements of the listed situations.
In addition, the final regulations adopted a commentator’s suggestion that a partner should not be treated as having the EROL when the partner’s risk is limited to the partner’s equity investment in the partnership. As a result, the final regulations disregard:
- Code Sec. 267(c)(1) when determining whether a UTP’s interest in an LTP is owned proportionately by or for the UTP’s partners when an LTP has direct EROL for a liability of the UTP, and
- Code Sec. 1563(e)(2) when determining whether a corporate partner in a partnership and a corporation owned by the partnership are members of the same controlled group when the corporation has direct EROL for a liability of the owner partnership.
To address a commentator’s concern that allowing related partners to choose among themselves who receives the allocation could prevent related partners from recognizing an uneconomic gain, the final regulations under Reg §1.752-4(b)(3) treat related partners as having the EROL for a partnership liability in proportion to each related partner’s interest in partnership profits.
Finally, the IRS included an ordering rule in the final regs to clarify how the proportionality rule interacts with the multiple partner rule and how the multiple partner rule interacts with the related partner exception.
Applicability dates.
The final regulations allow a partnership to apply the final rules to all liabilities with respect to returns filed on or after December 2, 2024, provided the partnership consistently applies all the rules in these final regulations to those liabilities.
However, the final regulations do not apply to refinanced debts to the extent of the amount and duration of the pre-modification liability. Instead, the rules in the regulations as in effect prior to December 2, 2024, continue to apply to those liabilities.
For more information about partners’ shares of liabilities of multi-tier partnerships, see Checkpoint’s Federal Tax Coordinator ¶ B-1672.
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