Tax practitioners have seen an avalanche of technical developments from the IRS and Treasury and the courts in the partnership area since the beginning of December 2013. Among them are five sets of proposed regulations, including the first set of regulations on Internal Revenue Code (IRC) §704(c)(1)(C) and a set of proposed regulations that would fundamentally change the way in which economic risk of loss is measured for purposes of allocating partnership liabilities. Other proposed regulation packages address the allocation of partnership recourse liabilities, unamortized costs in partnership technical terminations, and, at the beginning of the influx of developments, application of the net investment income tax to partnerships and other pass- through entities.
The IRS also issued a safe harbor revenue procedure for allocations of IRC §47 rehabilitation credits among partners after the Historic Boardwalk case, and the Tax Court addressed recognition of undistributed income allocations attributable to nonvested capital interests and the treatment of tax credit transfers by partnerships.
On January 29, 2014, the IRS published a sweeping proposed regulations project regarding disguised sales and the allocation of recourse and nonrecourse liabilities. In general, the preamble explains that issues in interpreting and applying the regulations under IRC §707(a)(2) since finalized in 1992. The preamble also explains that the IRS and Treasury believe it is appropriate to reconsider the rules under IRC §752 regarding the payment obligations that are recognized under Treas. Reg.§1.752-2(b)(3), the satisfaction of payment obligations under Treas. Reg. §1.752-2(b)(6), and the methods available for allocating excess nonrecourse liabilities under Treas. Reg. §1.752-3(a)(3).
Treatment of Multiple Liabilities
The proposed regulations add an example to demonstrate that, under the Treas. Reg. §1.707-5(b)debt-financed distribution exception to the disguised sale rule of Treas. Reg. §1.707-3, if more than one partner receives all or a portion of the debt proceeds of multiple liabilities that are treated as a single liability under Treas. Reg. §1.707-5(b), the debt proceeds will not be treated as consideration in a disguised sale to the extent of the partner’s allocable share of the single liability.
The preamble also describes a proposed ordering rule intended to ensure that the application of thedebt-financed distribution exception would not be minimized. A proposed example demonstrates that if a transfer of money is properly treated in part as a debt-financed distribution and in part as a reasonable guaranteed payment, then the amount of the transfer excluded from disguised sale treatment under the debt-financed distribution exception is determined before the determination of whether any remaining amount is excluded from disguised sale treatment under the exception for guaranteed payments.
The proposed regulations provide guidance regarding application of the pre-formation capital expenditure exception to disguised sale treatment in the case of multiple property transfers. Specifically the proposed regulations provide that the determination of whether the fair market value limitation and the exception to the fair market value limitation apply to reimbursements of capital expenditures is a separate determination for each property that qualifies for the exception.
Meaning of “Capital Expenditures”
The proposed regulations clarify the scope of the term “capital expenditures” for purposes of thepre-formation capital expenditures exception to disguised sale treatment; specifically, the term “capital expenditures” will have the same meaning as when used elsewhere in the IRC and regulations, except that the term includes capital expenditures that taxpayers elect to deduct but does not include deductible expenditures that taxpayers elect to treat as capital expenditures.
Coordination of Rules for Pre-Formation Capital Expenditures and Liabilities Traceable to Capital Expenditures
The proposed regulations also provide a rule coordinating the exception to disguised sale treatment forpre-formation capital expenditures and the rules regarding liabilities traceable to capital expenditures; specifically, the exception for pre-formation capital expenditures will not apply to the extent that a partner funded a capital expenditure through a borrowing and economic responsibility for that borrowing has shifted to another partner because there is no outlay by the partner to reimburse.
Additional Definition of “Qualified Liability”
The proposed regulations define as a “qualified liability” any liability incurred in connection with the conduct of a trade or business, provided the liability was not incurred in anticipation of the transfer and all of the assets material to that trade or business are transferred to the partnership. However, under the proposed regulations, if a partner incurred a liability within two years of a transfer of assets to a partnership, then—
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