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Loan guarantors are “generally comfortable” with vertical slice guarantees after the Internal Revenue Service issued regulations banning arrangements officials say don’t reflect economic reality, tax practitioners said.
The IRS issued regulations (T.D. 9788, REG-122855-15) last year that permit vertical slice guarantees, where partners have several, but not joint, liability on an obligation. The rules prohibit bottom-dollar guarantees, where a partner agrees to pay a partnership debt only if the bank collects less than the guaranteed amount from the entity.
Guarantors are open to deals, but these tend to involve a more detailed and specific conversation, Nicole D. Brown, a senior associate at Hogan Lovells in Washington, who advises real estate companies and investors, said Sept. 15 at the American Bar Association tax section meeting in Austin, Texas.
Bottom-dollar guarantees have been popular arrangements, but the IRS said they don’t represent real economic risk. While the guarantees have been used for many years, people have rarely paid on them, IRS officials say.
Guarantors “would prefer to enter into a bottom-dollar guarantee, but they are still willing to go with vertical slice and take on that increased risk,” said Maher Haddad, a partner Baker & McKenzie LLP in Chicago. These are generally seen in transactions with large real estate investment trusts, he said.
While there is more risk in these deals, there is also more diversification. The guarantee could be for hundreds of properties, instead of one, so some could go bad without a worst case scenario for the guarantor, said Clifford Warren, IRS senior counsel to the associate chief counsel (Passthroughs and Special Industries).
“It’s a blunt tool but it provides certainty, and everyone likes certainty,” Brown said.
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