Section 707 Regarding Disguised Sales, Generally, 4826-4839 [2014-01637]

Agencies

• Internal Revenue Service
• DEPARTMENT OF THE TREASURY

[Federal Register Volume 79, Number 20 (Thursday, January 30, 2014)]
[Proposed Rules]
[Pages 4826-4839]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2014-01637]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[REG-119305-11]
RIN 1545-BK29


Section 707 Regarding Disguised Sales, Generally

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking.

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SUMMARY: This document contains proposed regulations under section 707 
of the Internal Revenue Code (Code) relating to disguised sales of 
property to or by a partnership and under section 752 relating to the 
treatment of partnership liabilities. The proposed regulations address 
certain deficiencies and technical ambiguities in the section 707 
regulations and certain issues in determining partners' shares of 
liabilities under section 752. The proposed regulations affect 
partnerships and their partners.

DATES: Written or electronic comments and requests for a public hearing 
must be received by April 30, 2014.

ADDRESSES: Send submissions to: CC:PA:LPD:PR (REG-119305-11), Room 
5203, Internal Revenue Service, P.O. Box 7604, Ben Franklin Station, 
Washington, DC 20044. Submissions may be hand-delivered Monday through 
Friday between the hours of 8 a.m. and 4 p.m. to: CC:PA:LPD:PR (REG-
119305-11), Courier's Desk, Internal Revenue Service, 1111 Constitution 
Avenue NW., Washington, DC, or sent electronically, via the Federal 
eRulemaking Portal site at https://www.regulations.gov (indicate IRS and 
REG-119305-11).

FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulations, 
Deane M. Burke, (202) 317-5279; concerning submissions of comments and 
requests for a public hearing, Oluwafunmilayo (Funmi) Taylor, (202) 
317-6901 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

    The collection of information related to these proposed regulations 
under section 707 is reported on Form 8275, Disclosure Statement, and 
has been reviewed in accordance with the Paperwork Reduction Act (44 
U.S.C. 3507) and approved by the Office of Management and Budget under 
control number 1545-0889. Comments concerning the collection of 
information and the accuracy of estimated average annual burden and 
suggestions for reducing this burden should be sent to the Office of 
Management and Budget, Attn: Desk Officer for the Department of the 
Treasury, Office of Information and Regulatory Affairs, Washington, DC 
20503, with copies to the Internal Revenue Service, IRS Reports 
Clearance Officer, SE:W:CAR:MP:T:T:SP, Washington, DC 20224. Comments 
on the burden associated with this collection of information should be 
received by March 31, 2014.
    The collection of information in these proposed regulations is in 
proposed Sec. Sec.  1.707-5(a)(3)(ii) and 1.707-5(b)(2)(iii)(B) 
(regarding the reduction of a liability presumed to be anticipated) and 
Sec.  1.707-5(a)(7)(ii) (regarding a liability incurred within two 
years prior to a transfer of property). This information is required by 
the IRS to ensure that sections 707(a)(2)(B) and 752 of the Code and 
applicable regulations are properly applied respectively either to 
transfers between a partner and a partnership or for allocations of 
partnership liabilities. The respondents will be partners and 
partnerships.
    The collection of information in these proposed regulations under 
section 752 has been submitted to the Office of Management and Budget 
for review in accordance with the Paperwork Reduction Act of 1995 (44 
U.S.C. 3507(d)). Comments on the collection of information should be 
sent to the Office of Management and Budget, Attn: Desk Officer for the 
Department of the Treasury, Office of Information and Regulatory 
Affairs, Washington, DC 20503, with copies to the Internal Revenue 
Service, Attn: IRS Reports Clearance Officer, SE:W:CAR:MP:T:T:SP, 
Washington, DC 20224. Comments on the collection of information should 
be received by March 31, 2014. Comments are specifically requested 
concerning:
    Whether the proposed collection of information is necessary for the 
proper performance of the functions of the Internal Revenue Service, 
including whether the information will have practical utility;
    The accuracy of the estimated burden associated with the proposed 
collection of information (see below);
    How the quality, utility, and clarity of the information to be 
collected may be enhanced;
    How the burden of complying with the proposed collection of 
information may be minimized, including through the application of 
automated collection techniques or other forms of information 
technology; and
    Estimates of capital or start-up costs and costs of operation, 
maintenance, and purchase of service to provide information.
    The collection of information in this proposed regulation is in 
Sec.  1.752-2(b)(3)(iii)(C). This information is required to ensure 
proper allocations of partnership liabilities. This information will be 
used to determine the extent to which certain partners or related 
persons bear the economic risk of loss with respect to partnership 
liabilities. The collection of information is mandatory. The likely 
reporters are small and large businesses or organizations and trusts.
    Estimated total annual reporting burden: 8 million hours.
    The estimated annual burden per respondent varies from 6 minutes to 
2 hours, depending on individual circumstances, with an estimated 
average of 1 hour.
    Estimated number of respondents: 8 million.
    Estimated frequency of responses: On occasion.
    An agency may not conduct or sponsor, and a person is not required 
to respond to, a collection of information unless it displays a valid 
control number assigned by the Office of Management and Budget.
    Books or records relating to a collection of information must be 
retained as long as their contents may become material in the 
administration of any internal revenue law. Generally, tax returns and 
tax return information are confidential, as required by section 6103.

Background

    This document contains proposed amendments to the Income Tax 
Regulations (26 CFR part 1) under section 707 relating to disguised 
sales of property to or by a partnership and under section 752 relating 
to the treatment of partnership liabilities.
    Section 707(a)(2)(B) of the Code generally provides that, under 
regulations prescribed by the Secretary, related transfers to and by a 
partnership that, when viewed together, are more properly characterized 
as a sale or exchange of property, will be treated either as a 
transaction between the partnership and one who is not a

[[Page 4827]]

partner or between two or more partners acting other than in their 
capacity as partners. The legislative history of section 707(a)(2)(B) 
indicates Congress adopted the provision to prevent parties from 
characterizing a sale or exchange of property as a contribution to the 
partnership followed by a distribution from the partnership, thereby 
deferring or avoiding tax on the transaction. See H.R. Rep. No. 432, 
pt. 2, 98th Cong. 2nd Sess. 1216, 1218 (1984).
    On September 30, 1992, final regulations under section 707(a)(2) 
(TD 8439, 1992-2 CB 126) relating to disguised sales of property to and 
by partnerships were published in the Federal Register (57 FR 44974 as 
corrected on November 30, 1992, by 57 FR 56443) (existing regulations). 
Since publication of the existing regulations, the IRS and the Treasury 
Department have become aware of certain issues in interpreting or 
applying the regulations. On November 26, 2004, a notice of proposed 
rulemaking under section 707(a)(2)(B) (REG-149519-03, 2004-2 CB 1009) 
was published in the Federal Register (69 FR 68838) to add rules for 
disguised sales of partnership interests and to amend the existing 
regulations by revising, to a limited extent, the rules relating to 
disguised sales of property. The IRS and the Treasury Department noted 
in the preamble to those proposed regulations an awareness of certain 
deficiencies and technical ambiguities in the existing regulations 
under Sec. Sec.  1.707-3, 1.707-4, and 1.707-5, and requested comments 
on the scope and content of revisions to the existing regulations, but 
received none. The notice of proposed rulemaking was subsequently 
withdrawn on January 21, 2009, in Announcement 2009-4, 2009-1 CB 597. 
The IRS and the Treasury Department have, however, continued to study 
these issues, and set forth in the following section is a discussion of 
those areas in the existing regulations that the IRS and the Treasury 
Department have identified as requiring clarification or revision and 
the proposed changes to those areas.
    In addition, regulations under section 752 address the treatment of 
partnership recourse and nonrecourse liabilities. The IRS and the 
Treasury Department believe it is appropriate to reconsider the rules 
under section 752 regarding the payment obligations that are recognized 
under Sec.  1.752-2(b)(3), the satisfaction of payment obligations 
under Sec.  1.752-2(b)(6), and the methods available for allocating 
excess nonrecourse liabilities under Sec.  1.752-3(a)(3). Also 
discussed in the following section is an explanation of those areas in 
the section 752 regulations that the IRS and the Treasury Department 
have identified as requiring revision and the proposed changes to those 
areas.

Explanation of Provisions

1. Debt-Financed Distributions

    Section 1.707-3 of the existing regulations generally provides that 
a transfer of property by a partner to a partnership followed by a 
transfer of money or other consideration from the partnership to the 
partner will be treated as a sale of property by the partner to the 
partnership if, based on all the facts and circumstances, the transfer 
of money or other consideration would not have been made but for the 
transfer of the property and, for non-simultaneous transfers, the 
subsequent transfer is not dependent on the entrepreneurial risks of 
the partnership. Notwithstanding this general rule, the existing 
regulations provide several exceptions.
    One such exception in Sec.  1.707-5(b) of the existing regulations 
generally provides that a distribution of money to a partner is not 
taken into account for purposes of Sec.  1.707-3 to the extent the 
distribution is traceable to a partnership borrowing and the amount of 
the distribution does not exceed the partner's allocable share of the 
liability incurred to fund the distribution (the ``debt-financed 
distribution exception''). Under a special rule in the existing 
regulations, if a partnership transfers to more than one partner 
pursuant to a plan all or a portion of the proceeds of one or more 
liabilities, the debt-financed distribution exception is applied by 
treating all of the liabilities incurred pursuant to the plan as one 
liability. Thus, partners who are allocated shares of multiple 
liabilities are treated as being allocated a share of a single 
liability, to which any distributee partner's distribution of debt 
proceeds relates, rather than a share of each separate liability.
    To illustrate the application of this rule, the proposed 
regulations add an example to the existing regulations to demonstrate 
that 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 the special rule, 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.
    In addition, the IRS and the Treasury Department are aware that 
there is uncertainty as to whether, for purposes of Sec.  1.707-
5(b)(2), the amount of money transferred to a partner that is traceable 
to a partnership liability is reduced by any portion of such amount 
that is also excluded from disguised sale treatment under one or more 
of the exceptions in Sec.  1.707-4 (for example, because the transfer 
of money is also properly treated as a reasonable guaranteed payment). 
The IRS and the Treasury Department believe that the treatment of a 
transfer should first be determined under the debt-financed 
distribution exception, and any amount not excluded from Sec.  1.707-3 
under the debt-financed distribution exception should be tested to see 
if such amount would be excluded from Sec.  1.707-3 under a different 
exception in Sec.  1.707-4. This ordering rule ensures that the 
application of one of the exceptions in Sec.  1.707-4 does not minimize 
the application of the debt-financed distribution exception.

2. Preformation Expenditures

    Section 1.707-4(d) of the existing regulations provides an 
additional exception for reimbursements of preformation expenditures to 
the general rule in Sec.  1.707-3. Under Sec.  1.707-4(d), transfers to 
reimburse a partner for certain capital expenditures and costs incurred 
are not treated as part of a sale of property under Sec.  1.707-3 (the 
``exception for preformation capital expenditures'').
    The proposed regulations amend the exception for preformation 
capital expenditures to address three issues. First, the proposed 
regulations provide how the exception for preformation capital 
expenditures applies in the case of multiple property transfers. The 
exception for preformation capital expenditures generally applies only 
to the extent that ``the reimbursed capital expenditures do not exceed 
20 percent of the fair market value of such property at the time of the 
contribution.'' This fair market value limitation, however, does not 
apply if the fair market value of the contributed property does not 
exceed 120 percent of the partner's adjusted basis in the contributed 
property at the time of the contribution. The references to ``such 
property'' and ``contributed property'' in Sec.  1.707-4(d) are 
intended to refer to the single property for which the expenditures 
were made. Accordingly, in the case of multiple property contributions, 
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 made 
separately for each property that qualifies for the exception.
    Second, the proposed regulations clarify the scope of the term 
``capital

[[Page 4828]]

expenditures'' for purposes of Sec. Sec.  1.707-4 and 1.707-5. For 
purposes of Sec. Sec.  1.707-4 and 1.707-5, the term ``capital 
expenditures'' has the same meaning as the term ``capital 
expenditures'' has under the Code and applicable regulations, except 
that it includes capital expenditures taxpayers elect to deduct, and 
does not include deductible expenses taxpayers elect to treat as 
capital expenditures. The IRS and the Treasury Department are aware 
that taxpayers are uncertain whether the term capital expenditures 
includes only expenditures that are required to be capitalized under 
the Code. The purpose of the exception for preformation capital 
expenditures is to permit a partnership to reimburse a contributing 
partner for expenditures incurred with respect to contributed property. 
The IRS and the Treasury Department considered whether a contributing 
partner's capital expenditures for this purpose should be reduced by 
the benefit of the tax deduction the contributing partner received 
prior to contribution of the property either because the capital 
expenditure was currently deductible by the contributing partner or 
recovered through amortization or depreciation deductions. The proposed 
regulations, however, do not adopt such an approach because the 
approach would be too burdensome to administer.
    Finally, the proposed regulations provide a rule coordinating the 
exception for preformation capital expenditures and the rules regarding 
liabilities traceable to capital expenditures. Section 1.707-5 provides 
special rules for disguised sales relating to liabilities assumed or 
taken subject to by a partnership. Under Sec.  1.707-5(a)(1) of the 
existing regulations, a partnership's assumption of or taking property 
subject to a qualified liability in connection with a partner's 
transfer of property to the partnership is treated as a transfer of 
consideration to the partner only if the property transfer is otherwise 
treated as part of a sale. A liability constitutes a qualified 
liability of the partner to the extent the liability meets one of the 
four definitions of qualified liabilities under Sec.  1.707-5(a)(6). 
One of the enumerated qualified liabilities is a liability that is 
allocable under the rules of Sec.  1.163-8T to capital expenditures 
with respect to the property transferred to the partnership (the 
``capital expenditure qualified liability'').
    The IRS and the Treasury Department are aware that taxpayers are 
uncertain about whether a partner may qualify under the exception for 
preformation capital expenditures if those expenditures were funded 
with a capital expenditure qualified liability. For example, taxpayers 
are uncertain about whether a partner can finance its capital 
expenditures through a borrowing that is exempted as a qualified 
liability and can also be reimbursed for those expenditures without 
triggering sale treatment. The IRS and the Treasury Department believe 
that the exception for preformation capital expenditures applies only 
to the extent the distribution is in reimbursement of such 
expenditures. Thus, the proposed regulations provide that to the extent 
a partner funded a capital expenditure through a borrowing and economic 
responsibility for that borrowing has shifted to another partner, the 
exception for preformation capital expenditures should not apply 
because there is no outlay by the partner to reimburse.

3. Qualified Liabilities in a Trade or Business

    As previously mentioned, the existing regulations generally exclude 
qualified liabilities from disguised sale treatment. The legislative 
history of section 707(a)(2)(B) with respect to liabilities provides 
that Congress was ``concerned with transactions that attempt to 
disguise a sale of property and not with non-abusive transactions that 
reflect the various economic contributions of the partners. . . . For 
example . . . the transaction will be treated as a sale or exchange of 
property . . . to the extent the partner has received a loan related to 
the property in anticipation of the transaction and responsibility for 
repayment of the loan is transferred to the other partners.'' See H.R. 
Rep. No. 432, pt. 2, 98th Cong. 2nd Sess. 1216, 1220-1221 (1984).
    The existing regulations under Sec.  1.707-5(a)(6) provide four 
types of liabilities that are qualified liabilities. In addition to the 
capital expenditure qualified liabilities discussed previously, the 
existing regulations include as a qualified liability a liability 
incurred in the ordinary course of the trade or business in which 
property transferred to the partnership was used or held, but only if 
all of the assets that are material to that trade or business are 
transferred to the partnership (``ordinary course qualified 
liability''). There is no requirement that these two types of 
liabilities encumber the transferred property to be treated as 
qualified liabilities.
    The remaining two types of qualified liabilities are liabilities 
incurred more than two years before the transfer (or written agreement 
to transfer), and liabilities incurred within two years of the transfer 
(or written agreement to transfer) but not in anticipation of the 
transfer. Liabilities incurred by a partner within two years of the 
transfer, other than capital expenditure and ordinary course qualified 
liabilities, are presumed to be incurred in anticipation of the 
transfer unless the facts and circumstances clearly establish 
otherwise. With respect to both of these types of qualified 
liabilities, there is a requirement that the liability encumber the 
transferred property.
    The IRS and the Treasury Department believe the requirement that 
the liability encumber the transferred property is not necessary to 
carry out the purposes of section 707(a)(2)(B) when a liability was 
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. Accordingly, the proposed regulations 
add an additional definition of qualified liability to account for this 
type of liability. As under the existing regulations regarding 
liabilities other than capital expenditure and ordinary course 
qualified liabilities, if the partner incurred the liability within two 
years of the transfer of assets to the partnership, (i) the liability 
is presumed under Sec.  1.707-5(a)(7)(i) to have been incurred in 
anticipation of the transfer unless the facts and circumstances clearly 
establish that the liability was not incurred in anticipation of the 
transfer, and (ii) the treatment of the liability as a qualified 
liability under the new definition must be disclosed to the IRS under 
Sec.  1.707-8.

4. Anticipated Reduction

    Under the existing regulations, for purposes of the rules under 
section 707, a partner's share of a liability assumed or taken subject 
to by a partnership is determined by taking into account certain 
subsequent reductions in the partner's share of the liability. 
Specifically, a subsequent reduction in a partner's share of a 
liability is taken into account if (i) at the time that the partnership 
incurs, assumes, or takes property subject to the liability, it is 
anticipated that the partner's share of the liability will be 
subsequently reduced; and (ii) the reduction is part of a plan that has 
as one of its principal purposes minimizing the extent to which the 
distribution or assumption of, or taking property subject to, the 
liability is treated as part of a sale (the ``anticipated reduction 
rule''). The IRS and the Treasury Department are aware that there is 
uncertainty as to when a reduction is anticipatory because it is 
generally anticipated that all liabilities

[[Page 4829]]

will be repaid. Consistent with the overall approach of the existing 
regulations under section 707, the IRS and the Treasury Department 
believe that a reduction that is subject to the entrepreneurial risks 
of partnership operations is not an anticipated reduction, and the 
proposed regulations adopt this approach.
    In addition, the proposed regulations provide that if within two 
years of the partnership incurring, assuming, or taking property 
subject to the liability, a partner's share of the liability is reduced 
due to a decrease in the partner's or a related person's net value (as 
described in Part 8.a of the Explanation of Provisions section of this 
preamble), then the reduction will be presumed to be anticipated, 
unless the facts and circumstances clearly establish that the decrease 
in the net value was not anticipated. Any such reduction must be 
disclosed in accordance with Sec.  1.707-8.

5. Tiered Partnerships

    The existing regulations in Sec.  1.707-5(e), and Sec.  1.707-6(b) 
by applying rules similar to Sec.  1.707-5(e), currently provide only a 
limited tiered-partnership rule for cases in which a partnership 
succeeds to a liability of another partnership. Under those rules, if a 
lower-tier partnership succeeds to a liability of an upper-tier 
partnership, the liability in the lower-tier partnership retains the 
same characterization as either a qualified or a nonqualified liability 
that it had as a liability of the upper-tier partnership. Similarly, if 
an upper-tier partnership succeeds to a liability of a lower-tier 
partnership, the liability in the upper-tier partnership retains the 
same characterization as either a qualified or a nonqualified liability 
that it had as a liability of the lower-tier partnership that incurred 
the liability. Moreover, the existing regulations provide that a 
similar rule applies to other related party transactions involving 
liabilities to the extent provided by guidance in the Internal Revenue 
Bulletin. See, for example, Rev. Rul. 2000-44, 2000-2 CB 336.
    The proposed regulations add additional rules regarding tiered 
partnerships. First, the proposed regulations clarify that the debt-
financed distribution exception applies in a tiered partnership 
setting. Second, the proposed regulations provide rules regarding the 
characterization of liabilities attributable to a contributed 
partnership interest. Section 752(d) provides that in the case of a 
sale or exchange of an interest in a partnership, liabilities shall be 
treated in the same manner as liabilities in connection with the sale 
or exchange of property not associated with partnerships. Accordingly, 
a partner that contributes an interest in a partnership (lower-tier 
partnership) to another partnership (upper-tier partnership) must take 
into account its share of liabilities from the lower-tier partnership 
in applying the rules under Sec.  1.707-5. The IRS and the Treasury 
Department believe it is appropriate to treat the lower-tier 
partnership as an aggregate for purposes of determining whether the 
upper-tier partnership's share of the liabilities of the lower-tier 
partnership are qualified liabilities. Thus, these proposed regulations 
provide that a contributing partner's share of liabilities from a 
lower-tier partnership are treated as qualified liabilities to the 
extent the liability would be a qualified liability had the liability 
been assumed or taken subject to by the upper-tier partnership in 
connection with a transfer of all of the lower-tier partnership's 
property to the upper-tier partnership by the lower-tier partnership.

6. Treatment of Liabilities in Assets-Over Merger

    Section 1.752-1(f) provides for netting of increases and decreases 
in a partner's share of liabilities resulting from a single 
transaction. Under that rule, increases and decreases in partnership 
liabilities associated with a merger or consolidation are netted by the 
partners in the terminating partnership and the resulting partnership 
to determine the effect of a merger under section 752. The IRS and the 
Treasury Department believe that similar netting rules should apply 
with respect to the disguised sale rules and, accordingly, the proposed 
regulations extend the principles of Sec.  1.752-1(f) to determine the 
effect of the merger under the disguised sale rules.

7. Disguised Sales of Property by a Partnership to a Partner

    For disguised sales of property by a partnership to a partner, the 
existing regulations under Sec.  1.707-6 provide that rules similar to 
those in Sec.  1.707-5 (for disguised sales of property by a partner to 
a partnership) apply to determine the extent to which an assumption of 
or taking property subject to a liability by a partner, in connection 
with a transfer of property by a partnership, is considered part of a 
sale. More specifically, the existing regulations provide that if the 
partner assumes or takes property subject to a liability that is not a 
qualified liability, the amount treated as consideration transferred to 
the partnership is the amount that the liability assumed or taken 
subject to by the partner exceeds the partner's share of that liability 
immediately before the transfer. Thus, if a transferee partner had a 
100 percent share of a liability immediately before a transfer in which 
the transferee partner assumed the liability, then no sale is treated 
as occurring between the partnership and the partner with respect to 
the liability assumption, irrespective of the period of time during 
which the partnership liability is outstanding and the period of time 
in which the partnership liability is allocated to the partner.
    The IRS and the Treasury Department are studying these rules and 
believe it may be inappropriate to take into account a transferee 
partner's share of a partnership liability immediately prior to a 
distribution if the transferee partner did not have economic exposure 
with respect to the partnership liability for a meaningful period of 
time before appreciated property is distributed to that partner subject 
to the liability. Thus, the IRS and the Treasury Department are 
considering, and request comments on, whether the rules under Sec.  
1.707-6 should be amended to provide that a transferee partner's share 
of an assumed liability immediately before a distribution is taken into 
account for purposes of determining the consideration transferred to 
the partnership only to the extent of the partner's lowest share of the 
liability within some meaningful period of time, for example, 12 
months.

8. Partner's Share of Partnership Liabilities

A. Recourse Liabilities
    The existing regulations under section 1.752-2 provide that a 
partner's share of a recourse partnership liability equals the portion 
of the liability, if any, for which the partner or related person bears 
the economic risk of loss. A partner generally bears the economic risk 
of loss for a partnership liability to the extent the partner, or a 
related person, would be obligated to make a payment if the 
partnership's assets were worthless and the liability became due and 
payable. Subject to an anti-abuse rule and the disregarded entity net 
value requirement of Sec.  1.752-2(k), Sec.  1.752-2(b)(6) assumes that 
all partners and related persons will actually satisfy their payment 
obligations, irrespective of their actual net worth, unless the facts 
and circumstances indicate a plan to circumvent or avoid the obligation 
(the ``satisfaction presumption''). Thus, for purposes of allocating 
partnership liabilities, Sec.  1.752-2 adopts an ultimate liability 
test under a worst-case

[[Page 4830]]

scenario. Under this test, the regulations would generally allocate an 
otherwise nonrecourse liability of the partnership to a partner that 
guarantees the liability even if the lender and the partnership 
reasonably anticipate that the partnership will be able to satisfy the 
liability with either partnership profits or capital.
    The IRS and the Treasury Department have considered whether the 
approach of the existing regulations under Sec.  1.752-2 is appropriate 
given that, in most cases, a partnership will satisfy its liabilities 
with partnership profits, the partnership's assets do not become 
worthless, and the payment obligations of partners or related persons 
are not called upon. The IRS and the Treasury Department are concerned 
that some partners or related persons have entered into payment 
obligations that are not commercial solely to achieve an allocation of 
a partnership liability to such partner. The IRS and the Treasury 
Department believe that section 79 of the Tax Reform Act of 1984 (Pub. 
L. 98-369), which overruled the decision in Raphan v. United States, 3 
Cl. Ct. 457 (1983) (holding that a guarantee by a general partner of an 
otherwise nonrecourse liability of the partnership did not require the 
partner to be treated as personally liable for that debt), and directed 
the Treasury Department to prescribe regulations under section 752 
relating to the treatment of guarantees and other payment obligations, 
was intended to ensure that bona fide, commercial payment obligations 
would be given effect under section 752.
    Accordingly, the proposed regulations provide a rule that 
obligations to make a payment with respect to a partnership liability 
(excluding those imposed by state law) will not be recognized for 
purposes of section 752 unless certain factors are present. These 
factors, if satisfied, are intended to establish that the terms of the 
payment obligation are commercially reasonable and are not designed 
solely to obtain tax benefits. Specifically, the rule requires a 
partner or related person to maintain a commercially reasonable net 
worth during the term of the payment obligation or be subject to 
commercially reasonable restrictions on asset transfers for inadequate 
consideration. In addition, the partner or related person must provide 
commercially reasonable documentation regarding its financial condition 
and receive arm's length consideration for assuming the payment 
obligation. The rule also requires that the payment obligation's term 
must not end prior to the term of the partnership liability and that 
the primary obligor or any other obligor must not be required to hold 
money or other liquid assets in an amount that exceeds the reasonable 
needs of such obligor. The rule would also prevent certain so-called 
``bottom-dollar'' guarantees from being recognized for purposes of 
section 752.
    Moreover, the IRS and the Treasury Department are concerned that 
some partners or related persons might attempt to use certain 
structures or arrangements to circumvent the rules included in these 
proposed regulations with respect to bottom-dollar guarantees. For 
example, a financial intermediary might artificially convert a single 
mortgage loan into senior and junior tranches using a wrap-around 
mortgage or other device with a principal purpose of creating tranches 
for partners to guarantee that result in exposure tantamount to a 
bottom-dollar guarantee. Accordingly, the proposed regulations revise 
the anti-abuse rule under Sec.  1.752-2(j) to address the use of 
intermediaries, tiered partnerships, or similar arrangements to avoid 
the bottom-dollar guarantee rules. The IRS and the Treasury Department 
request comments on whether other structures or arrangements might be 
used to circumvent the rules regarding bottom-dollar guarantees, and 
whether the final regulations should broaden the anti-abuse rule 
further to address any such structures or arrangements.
    The IRS and the Treasury Department also acknowledge that the 
proposed regulations relating to guarantees and indemnities draw lines 
that, among other things, preclude recognition of a payment obligation 
for a portion, rather than 100 percent, of each dollar of a partnership 
liability to which the payment obligation relates (a so-called vertical 
slice of the partnership liability) (see Sec.  1.752-2(f) Example 12 in 
the proposed regulations). The IRS and the Treasury Department request 
comments on whether, and under what circumstances, the final 
regulations should permit recognition of such a payment obligation. In 
addition, the IRS and the Treasury Department request comments on 
whether the special rule under Sec.  1.752-2(e) (and related Sec.  
1.752-2(f) Example 7) should be removed from the final regulations or 
revised to require that 100 percent of the total interest that will 
accrue on a partnership nonrecourse liability be guaranteed.
    As was previously noted, the satisfaction presumption assumes that 
all partners and related persons will actually satisfy their payment 
obligations, unless the facts and circumstances indicate a plan to 
circumvent or avoid the obligation. The satisfaction presumption does 
not apply, however, to the payment obligations of disregarded entities. 
Instead, the payment obligation of a disregarded entity for which a 
partner is treated as bearing the economic risk of loss is taken into 
account only to the extent of the net value of the disregarded entity, 
as determined under Sec.  1.752-2(k). The preamble to the proposed 
regulations under Sec.  1.752-2(k) requested comments regarding whether 
the rules for disregarded entities should be extended to the payment 
obligations of other entities. Some commenters opposed extending the 
rules to other entities, while other commenters suggested that the 
anti-abuse rule in Sec.  1.752-2(j) could be expanded to cover certain 
situations involving thinly capitalized entities. One commenter 
suggested that the anti-abuse rule should apply if a substantially 
undercapitalized subsidiary of a consolidated group of corporations or 
a substantially undercapitalized passthrough entity (other than a 
disregarded entity) is utilized as the partner (or related obligor) for 
a principal purpose of limiting its owner's risk of loss in respect of 
existing partnership liabilities, and obtaining tax benefits for its 
owners (or other members of the consolidated group) that would not be 
available but for the additional tax basis in the partnership interest 
that results from the satisfaction presumption. Although the final 
regulations under Sec.  1.752-2(k) did not extend the rules for 
disregarded entities to other entities, the IRS and the Treasury 
Department indicated that they would continue to study the issue of 
extending the net value approach for disregarded entities to other 
entities.
    After further consideration, the IRS and the Treasury Department 
believe that there are circumstances in addition to those involving 
disregarded entities under which the satisfaction presumption is not 
appropriate. Thus, the proposed regulations turn off the satisfaction 
presumption by extending the net value requirement of Sec.  1.752-2(k) 
to all partners or related persons, including grantor trusts, other 
than individuals and decedent's estates for payment obligations 
associated with liabilities that are not trade payables. In situations 
in which the satisfaction presumption is turned off, the proposed 
regulations provide that the partner's or related person's payment 
obligation is recognized only to the extent of the partner's or related 
person's net value as of the allocation date. A partner or related 
person that is not a disregarded entity is treated as a disregarded 
entity for purposes of determining net value

[[Page 4831]]

under Sec.  1.752-2(k). The IRS and the Treasury Department request 
comments on whether it would be clearer if all the net value 
requirement rules were consolidated in Sec.  1.752-2(k).
    The IRS and the Treasury Department considered further extending 
the net value requirement of Sec.  1.752-2(k) to partners and related 
persons that are individuals and decedent's estates, but decided not to 
require such persons to comply with the net value requirement of Sec.  
1.752-2(k) because of the nature of personal guarantees. However, 
applying this less restrictive standard to individuals and decedent's 
estates may disadvantage other entities that enter into partnerships 
with individuals or decedent's estates. Thus, the IRS and the Treasury 
Department request comments on whether the final regulations should 
extend the net value requirement of Sec.  1.752-2(k) to all partners 
and related persons. The IRS and the Treasury Department also request 
comments on the application of the net value requirement of Sec.  
1.752-2(k) to tiered partnerships.
    Finally, in determining the amount of any obligation of a partner 
to make a payment to a creditor or a contribution to the partnership 
with respect to a partnership liability, Sec.  1.752-2(b)(1) reduces 
the partner's payment obligation by the amount of any reimbursement 
that the partner would be entitled to receive from another partner, a 
person related to another partner, or the partnership. The IRS and the 
Treasury Department have considered whether a right to be reimbursed 
for a payment or contribution by an unrelated person (for example, 
pursuant to an indemnification agreement from a third party) should be 
taken into account in the same manner and have concluded that any 
source of reimbursement that effectively eliminates the partner's 
payment risk should cause a payment obligation to be disregarded. 
Therefore, the proposed regulations change the rule in Sec.  1.752-
2(b)(1) to reduce the partner's payment obligation by the amount of any 
right to reimbursement from any person.
B. Nonrecourse Liabilities
    The existing regulations under Sec.  1.752-3 contain rules for 
determining a partner's share of a nonrecourse liability of a 
partnership, including the partner's share of excess nonrecourse 
liabilities under Sec.  1.752-3(a)(3). Section 1.752-3(a)(3) provides 
various methods to determine a partner's share of the excess 
nonrecourse liabilities. Under one method, a partner's share of excess 
nonrecourse liabilities is determined in accordance with the partner's 
share of partnership profits. For this purpose, the partnership 
agreement may specify the partners' interests in partnership profits so 
long as the interests so specified are reasonably consistent with 
allocations (that have substantial economic effect under the section 
704(b) regulations) of some other significant item of partnership 
income or gain (the ``significant item method''). Alternatively, excess 
nonrecourse liabilities may be allocated among the partners in the 
manner that deductions attributable to those liabilities are reasonably 
expected to be allocated (the ``alternative method''). Similar to the 
significant item method, under Sec.  1.704-2(e)(2), the partnership 
agreement may allocate nonrecourse deductions in a manner that is 
reasonably consistent with allocations that have substantial economic 
effect of some other significant partnership item attributable to the 
property securing the nonrecourse liability.
    The IRS and the Treasury Department believe that the allocation of 
excess nonrecourse liabilities in accordance with the significant item 
method and the alternative method may not properly reflect a partner's 
share of partnership profits that are generally used to repay such 
liabilities because the allocation of the significant item may not 
necessarily reflect the overall economic arrangement of the partners. 
Therefore, the proposed regulations remove the significant item method 
and the alternative method from Sec.  1.752-3(a)(3).
    The IRS and the Treasury Department, however, are aware of the 
difficulty in determining a partner's interest in partnership profits 
in other than very simple partnerships and, therefore, recognize the 
need to have a bright-line measure of a partner's interest in 
partnership profits. The IRS and the Treasury Department considered 
several alternatives and believe that, for this purpose, an appropriate 
proxy of a partner's interest in partnership profits, and one that can 
provide the needed certainty, is a partner's liquidation value 
percentage, determined upon formation of the partnership and 
redetermined upon the most recent occurrence of an event described in 
Sec.  1.704-1(b)(2)(iv)(f)(5), whether or not the capital accounts of 
the partners are adjusted under Sec.  1.704-1(b)(2)(iv)(f) in 
connection with such event. A partner's liquidation value percentage is 
the ratio (expressed as a percentage) of the liquidation value of the 
partner's interest in the partnership to the liquidation value of all 
of the partners' interests in the partnership. The proposed regulations 
adopt the liquidation value percentage approach.
    For purposes of the proposed rule, the liquidation value of a 
partner's interest in a partnership is the amount of cash the partner 
would receive with respect to the interest if, immediately after 
formation of the partnership or the occurrence of the event described 
in Sec.  1.704-1(b)(2)(iv)(f)(5), as the case may be, the partnership 
sold all of its assets for cash equal to the fair market value of such 
property (taking into account section 7701(g)), satisfied all of its 
liabilities (other than those described in Sec.  1.752-7), paid an 
unrelated third party to assume all of its Sec.  1.752-7 liabilities in 
a fully taxable transaction, and then liquidated. The proposed 
regulations also provide an example illustrating the new liquidation 
value approach in place of Example 2 in Sec.  1.752-3(c) illustrating 
the alternative method. As the proposed example illustrates, a change 
in the partners' shares of partnership liabilities as a result of an 
event described in Sec.  1.704-1(b)(2)(iv)(f)(5) is taken into account 
in determining the tax consequences of the event that gave rise to such 
change.
    The IRS and the Treasury Department are aware that the liquidation 
value approach may not precisely measure a partner's interest in 
partnership profits but believe that the approach is a better proxy 
than the significant item and alternative methods and is still 
administrable. The IRS and the Treasury Department request comments on 
other methods that reasonably measure a partner's interest in 
partnership profits that are not overly burdensome. In addition, the 
IRS and the Treasury Department request comments on whether exceptions 
should be provided to exclude certain events from triggering a 
redetermination of the partners' liquidation values.

Proposed Applicability Dates

    The regulations under section 707 are proposed to apply to 
transactions with respect to which all transfers occur on or after the 
date these regulations are published as final regulations in the 
Federal Register. The regulations under Sec.  1.752-2 are proposed to 
apply to liabilities incurred or assumed by a partnership and to 
payment obligations imposed or undertaken with respect to a partnership 
liability on or after the date these regulations are published as final 
regulations in the Federal Register. The regulations under Sec.  1.752-
3 are proposed to apply to liabilities incurred or assumed by a 
partnership on or after the date these regulations are published as 
final regulations in the Federal Register. The IRS and the Treasury

[[Page 4832]]

Department anticipate that the final regulations under section 752 will 
permit a partnership to apply the provisions contained in the final 
regulations to all of its liabilities as of the beginning of the first 
taxable year of the partnership ending on or after the date these 
regulations are published as final regulations in the Federal Register.
    The proposed regulations also provide transitional relief for any 
partner whose allocable share of partnership liabilities under Sec.  
1.752-2 exceeds its adjusted basis in its partnership interest on the 
date the proposed regulations are finalized. Under this transitional 
relief, the partner can continue to apply the existing regulations 
under Sec.  1.752-2 for a seven-year period to the extent that the 
partner's allocable share of partnership liabilities exceeds the 
partner's adjusted basis in its partnership interest on the date the 
proposed regulations are finalized. The amount of partnership 
liabilities subject to transitional relief will be reduced for certain 
reductions in the amount of liabilities allocated to that partner under 
the transition rules and, upon the sale of any partnership property, 
for any excess of tax gain (including section 704(c) gain) allocated to 
the partner less the partner's share of amount realized.

Special Analyses

    It has been determined that this notice of proposed rulemaking is 
not a significant regulatory action as defined in Executive Order 
12866, as supplemented by Executive Order 13563. Therefore, a 
regulatory assessment is not required. It also has been determined that 
section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) 
does not apply to these regulations. It is hereby certified that the 
collection of information in these regulations will not have a 
significant economic impact on a substantial number of small entities. 
This certification is based on the fact that the amount of time 
necessary to report the required information will be minimal in that it 
requires partners that are business entities and trusts to provide 
information they already maintain or can easily obtain to their 
respective partnership. Moreover, it should take a partner no more than 
2 hours to satisfy the information requirement in these regulations. 
Accordingly, a Regulatory Flexibility Analysis under the Regulatory 
Flexibility Act (5 U.S.C. chapter 6) does not apply. Pursuant to 
section 7805(f) of the Code, this notice of proposed rulemaking has 
been submitted to the Chief Counsel for Advocacy of the Small Business 
Administration for comment on its impact on small business.

Comments and Requests for a Public Hearing

    Before these proposed regulations are adopted as final regulations, 
consideration will be given to any written comments (a signed original 
and eight (8) copies) or electronic comments that are submitted timely 
to the IRS. The IRS and the Treasury Department request comments on all 
aspects of the proposed regulations. All comments will be available for 
public inspection and copying at www.regulations.gov or upon request. A 
public hearing will be scheduled if requested in writing by a person 
who timely submits written comments. If a public hearing is scheduled, 
notice of the date, time, and place of the hearing will be published in 
the Federal Register.

Drafting Information

    The principal author of these regulations is Deane M. Burke of the 
Office of the Associate Chief Counsel (Passthroughs & Special 
Industries), IRS. However, other personnel from the IRS and the 
Treasury Department participated in their development.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Proposed Amendments to the Regulations

    Accordingly, 26 CFR part 1 is proposed to be amended as follows:

PART 1--INCOME TAXES

0
Paragraph 1. The authority citation for part 1 continues to read in 
part as follows:

    Authority:  26 U.S.C. 7805 * * *

    Sections 1.707-2 through 1.707-9 also issued under 26 U.S.C. 
707(a)(2)(B).


Sec.  1.704-2  [Amended]

0
Par. 2. Section 1.704-2 is amended by:
0
a. Removing the language ``and (vii)'' in paragraph (d)(2)(ii).
0
b. Removing the language ``Example (1)(viii) and (ix)'' in paragraph 
(i)(2) and adding the language ``Example (1)(vii) and (viii)'' in its 
place.
0
c. Removing the language ``Example (1)(viii)'' in paragraph (i)(5) and 
adding the language ``Example (1)(vii)'' in its place.
0
d. Removing Example 1(vii) in paragraph (m) and redesignating Examples 
1(viii) and (ix) as Examples 1(vii) and (viii) respectively.
0
e. Removing the language ``Example (1)(viii)'' in newly redesignated 
Example (1)(viii) in paragraph (m) and adding the language ``Example 
(1)(vii)'' in its place.
0
Par. 3. Section 1.707-0 is amended by:
0
a. Adding entries for Sec. Sec.  1.707-4(d)(1), (d)(2), (d)(3), and 
(f).
0
b. Adding an entry for Sec.  1.707-5(b)(3).
0
c. Redesignating the entry for Sec.  1.707-5(f) as Sec.  1.707-5(g) and 
adding a new entry for Sec.  1.707-5(f).
    The additions read as follows:


Sec.  1.707-0  Table of contents.

* * * * *


Sec.  1.707-4  Disguised sales of property to partnership; special 
rules applicable to guaranteed payments, preferred returns, operating 
cash flow distributions, and reimbursements of preformation 
expenditures.

* * * * *
    (d) * * *
    (1) In general.
    (2) Special rule for certain qualified liabilities.
    (3) Scope of capital expenditures.
* * * * *
    (f) Ordering rule cross reference.
* * * * *


Sec.  1.707-5  Disguised sales of property to partnership; special 
rules relating to liabilities.

* * * * *
    (b) * * *
    (3) Ordering rule.
* * * * *
    (f) Netting liabilities in assets-over merger or consolidation.
* * * * *
0
Par. 4. Section 1.707-4 is amended by:
0
a. Adding the language ``(1) In general.'' after the heading for 
paragraph (d).
0
b. Redesignating paragraph (d)(1) as paragraph (d)(1)(i).
0
c. Redesignating paragraph (d)(2) as paragraph (d)(1)(ii).
0
d. Redesignating paragraph (d)(2)(i) as paragraph (d)(1)(ii)(A).
0
e. Redesignating paragraph (d)(2)(ii) as paragraph (d)(1)(ii)(B).
0
f. Revising the second sentence in newly redesignated paragraph 
(d)(1)(ii)(B) and adding a new sentence at the end of newly 
redesignated paragraph (d)(1)(ii)(B).
0
g. Adding new paragraphs (d)(2), (d)(3), and (f).
    The additions and revisions read as follows:

[[Page 4833]]

Sec.  1.707-4  Disguised sales of property to partnership; special 
rules applicable to guaranteed payments, preferred returns, operating 
cash flow distributions, and reimbursements of preformation 
expenditures.

* * * * *
    (d) * * *
    (1) In general. * * *
    (ii) * * *
    (B) * * * However, the 20 percent of fair market value limitation 
of this paragraph (d)(1)(ii)(B) does not apply if the fair market value 
of the contributed property does not exceed 120 percent of the 
partner's adjusted basis in the contributed property at the time of the 
contribution. This paragraph (d)(1)(ii)(B) shall be applied on a 
property-by-property basis.
    (2) Special rule for certain qualified liabilities. For purposes of 
paragraph (d)(1) of this section, if the capital expenditures were 
funded by a liability defined in Sec.  1.707-5(a)(6)(i)(C) that is 
assumed or taken subject to by the partnership in connection with a 
transfer of property to the partnership by a partner, a transfer of 
money or other consideration by the partnership to the partner is not 
treated as made to reimburse the partner for such capital expenditures 
to the extent the transfer of money or other consideration by the 
partnership to the partner exceeds the partner's share of the liability 
(as determined under Sec.  1.707-5(a)(2)).
    (3) Scope of capital expenditures. For purposes of this section and 
Sec.  1.707-5, the term capital expenditures has the same meaning as 
the term capital expenditures has under the Code and applicable 
regulations, except that it includes capital expenditures taxpayers 
elect to deduct, and does not include deductible expenses taxpayers 
elect to treat as capital expenditures.
* * * * *
    (f) Ordering rule cross reference. For payments or transfers by a 
partnership to a partner to which the rules under this section and 
Sec.  1.707-5(b) apply, see the ordering rule under Sec.  1.707-
5(b)(3).
0
Par. 5. Section 1.707-5 is amended by:
0
a. Removing the language ``or would be treated as a recourse liability 
under that section if it were treated as a partnership liability for 
purposes of that section'' at the end of paragraph (a)(2)(i).
0
b. Removing the language ``or would be a nonrecourse liability of the 
partnership under Sec.  1.752-1(a)(2) if it were treated as a 
partnership liability for purposes of that section'' at the end of 
paragraph (a)(2)(ii).
0
c. Revising paragraph (a)(3).
0
d. Revising paragraph (a)(6)(i)(C).
0
e. Removing the language ``and'' at the end of paragraph (a)(6)(i)(D) 
and adding the language ``or'' in its place.
0
f. Adding paragraph (a)(6)(i)(E).
0
g. Revising paragraph (a)(7)(ii).
0
h. Adding a sentence at the end of paragraph (b)(1).
    i. Removing the language ``property'' in paragraph (b)(2)(i)(A) and 
adding the language ``consideration'' in its place.
0
j. Revising paragraph (b)(2)(iii).
0
k. Adding paragraph (b)(3).
0
l. Designating the text of paragraph (e) after its subject heading as 
paragraph (e)(1).
0
m. Adding paragraph (e)(2).
0
n. Redesignating paragraph (f) as paragraph (g) and adding new 
paragraph (f).
0
o. Revising Example 10 in newly redesignated paragraph (g).
0
p. Redesignating Example 11 in newly redesignated paragraph (g) as 
Example 14 and adding new Examples 11, 12, and 13.
    The additions and revisions read as follows:


Sec.  1.707-5  Disguised sales of property to partnership; special 
rules relating to liabilities.

    (a) * * *
    (3) Reduction of partner's share of liability--(i) For purposes of 
this section, a partner's share of a liability, immediately after a 
partnership assumes or takes property subject to the liability, is 
determined by taking into account a subsequent reduction in the 
partner's share if--
    (A) At the time that the partnership assumes or takes property 
subject to the liability, it is anticipated that the transferring 
partner's share of the liability will be subsequently reduced;
    (B) The anticipated reduction is not subject to the entrepreneurial 
risks of partnership operations; and
    (C) The reduction of the partner's share of the liability is part 
of a plan that has as one of its principal purposes minimizing the 
extent to which the assumption of or taking property subject to the 
liability is treated as part of a sale under Sec.  1.707-3.
    (ii) If within two years of the partnership assuming or taking 
property subject to the liability, a partner's share of the liability 
is reduced due to a decrease in the net value of the partner or related 
person for purposes of Sec.  1.752-2(k), the reduction will be presumed 
to be anticipated, unless the facts and circumstances clearly establish 
that the decrease in the net value was not anticipated. Any such 
reduction must be disclosed in accordance with Sec.  1.707-8.
* * * * *
    (6) * * *
    (i) * * *
    (C) A liability that is allocable under the rules of Sec.  1.163-8T 
to capital expenditures (as described under Sec.  1.707-4(d)(3)) with 
respect to the property;
* * * * *
    (E) A liability that was not incurred in anticipation of the 
transfer of the property to a partnership, but that was incurred in 
connection with a trade or business in which property transferred to 
the partnership was used or held but only if all the assets related to 
that trade or business are transferred other than assets that are not 
material to a continuation of the trade or business (see paragraph 
(a)(7) of this section for further rules regarding a liability incurred 
within two years of a transfer presumed to be in anticipation of the 
transfer); and
* * * * *
    (7) * * *
    (ii) Disclosure of transfers of property subject to liabilities 
incurred within two years of the transfer. A partner that treats a 
liability assumed or taken subject to by a partnership in connection 
with a transfer of property as a qualified liability under paragraph 
(a)(6)(i)(B) of this section or under paragraph (a)(6)(i)(E) of this 
section (if the liability was incurred by the partner within the two-
year period prior to the earlier of the date the partner agrees in 
writing to transfer the property or the date the partner transfers the 
property to the partnership) must disclose such treatment to the 
Internal Revenue Service in accordance with Sec.  1.707-8.
    (b) * * *
    (1) * * * For purposes of paragraph (b) of this section, an upper-
tier partnership's share of the liabilities of a lower-tier partnership 
that are treated as a liability of the upper-tier partnership under 
Sec.  1.752-4(a) shall be treated as a liability of the upper-tier 
partnership incurred on the same day the liability was incurred by the 
lower-tier partnership.
    (2) * * *
    (iii) Reduction of partner's share of liability--(A) For purposes 
of paragraph (b)(2) of this section, a partner's share of a liability 
immediately after a partnership incurs the liability is determined by 
taking into account a subsequent reduction in the partner's share if--
    (1) At the time that the partnership incurs the liability, it is 
anticipated that the partner's share of the liability that is allocable 
to a transfer of money or other consideration to the partner will be 
reduced subsequent to the transfer;

[[Page 4834]]

    (2) The anticipated reduction is not subject to the entrepreneurial 
risks of partnership operations; and
    (3) The reduction of the partner's share of the liability is part 
of a plan that has as one of its principal purposes minimizing the 
extent to which the partnership's distribution of the proceeds of the 
borrowing is treated as part of a sale.
    (B) If within two years of the partnership incurring the liability, 
a partner's share of the liability is reduced due to a decrease in the 
net value of the partner or a related person for purposes of Sec.  
1.752-2(k), the reduction will be presumed to be anticipated, unless 
the facts and circumstances clearly establish that the decrease in the 
net value was not anticipated. Any such reduction must be disclosed in 
accordance with Sec.  1.707-8.
    (3) Ordering rule. The treatment of a transfer of money or other 
consideration under paragraph (b) of this section is determined before 
applying the rules under Sec.  1.707-4.
* * * * *
    (e) * * *
    (2) If an interest in a partnership that has one or more 
liabilities (the lower-tier partnership) is transferred to another 
partnership (the upper-tier partnership), the upper-tier partnership's 
share of any liability of the lower-tier partnership that is treated as 
a liability of the upper-tier partnership under Sec.  1.752-4(a) is 
treated as a qualified liability under Sec.  1.707-5(a)(6)(i) to the 
extent the liability would be a qualified liability under Sec.  1.707-
5(a)(6)(i) had the liability been assumed or taken subject to by the 
upper-tier partnership in connection with a transfer of all of the 
lower-tier partnership's property to the upper-tier partnership by the 
lower-tier partnership.
    (f) Netting liabilities in assets-over merger or consolidation. 
When two or more partnerships merge or consolidate under section 
708(b)(2)(A), as described in Sec.  1.708-1(c)(3)(i), any increases or 
decreases in partnership liabilities associated with the merger or 
consolidation are netted by a partner in the terminating partnership 
and the resulting partnership for purposes of applying Sec. Sec.  
1.707-3 through 1.707-5 to transfers of money or other consideration by 
the terminating partnership to the partner.
    (g) * * *
    Example 10. Treatment of debt-financed transfers of 
consideration by partnership. (i) K transfers property Z to 
partnership KL in exchange for an interest in KL on April 9, 2014. 
On September 13, 2014, KL incurs a liability of $20,000. On November 
17, 2014, KL transfers $20,000 to K, and $10,000 of this transfer is 
allocable under the rules of Sec.  1.163-8T to proceeds of the 
partnership liability incurred on September 13, 2014. The remaining 
$10,000 is paid from other partnership funds. Assume that, under 
section 752 and the corresponding regulations, the $20,000 liability 
incurred on September 13, 2014, is a recourse liability of KL and 
K's share of that liability is $10,000 on November 17, 2014.
    (ii) Because a portion of the transfer made to K on November 17, 
2014, is allocable under Sec.  1.163-8T to proceeds of a partnership 
liability that was incurred by the partnership within 90 days of 
that transfer, K is required to take the transfer into account in 
applying the rules of this section and Sec.  1.707-3 only to the 
extent that the amount of the transfer exceeds K's allocable share 
of the liability used to fund the transfer. K's allocable share of 
the $20,000 liability used to fund $10,000 of the transfer to K is 
$5,000 (K's share of the liability ($10,000) multiplied by the 
fraction obtained by dividing--
    (A) The amount of the liability that is allocable to the 
distribution to K ($10,000); by
    (B) The total amount of such liability ($20,000)).
    (iii) Therefore, K is required to take into account only $15,000 
of the $20,000 partnership transfer to K for purposes of this 
section and Sec.  1.707-3. Under these facts, assuming the within-
two-year presumption is not rebutted, this $15,000 transfer will be 
treated under the rule in Sec.  1.707-3 as part of a sale by K of 
property Z to KL.
    Example 11. Treatment of debt-financed transfers of 
consideration and transfers characterized as guaranteed payments by 
a partnership. (i) The facts are the same as in Example 10, except 
that the entire $20,000 transfer to K is allocable under the rules 
of Sec.  1.163-8T to proceeds of the partnership liability incurred 
on September 13, 2014. In addition, the partnership agreement 
provides that K is to receive a guaranteed payment for the use of 
K's capital in the amount of $10,000 in each of the three years 
following the transfer of property Z. Ten thousand dollars of the 
transfer made to K on November 17, 2014, is pursuant to this 
provision of the partnership agreement. Assume that the guaranteed 
payment to K constitutes a reasonable guaranteed payment within the 
meaning of Sec.  1.707-4(a)(3).
    (ii) Under these facts, the rules under both Sec.  1.707-4(a) 
and Sec.  1.707-5(b) apply to the November 17, 2014 transfer to K by 
the partnership. Thus, the ordering rule in Sec.  1.707-5(b)(3) 
requires that the Sec.  1.707-5(b) debt-financed distribution rules 
apply first to determine the treatment of the $20,000 transfer. 
Because the entire transfer made to K on November 17, 2014, is 
allocable under Sec.  1.163-8T to proceeds of a partnership 
liability that was incurred by the partnership within 90 days of 
that transfer, K is required to take the transfer into account in 
applying the rules of this section and Sec.  1.707-3 only to the 
extent that the amount of the transfer exceeds K's allocable share 
of the liability used to fund the transfer. K's allocable share of 
the $20,000 liability used to fund the transfer to K is $10,000 (K's 
share of the liability ($10,000) multiplied by the fraction obtained 
by dividing--
    (A) The amount of the liability that is allocable to the 
distribution to K ($20,000); by
    (B) The total amount of such liability ($20,000)).
    (iii) The remaining $10,000 amount of the transfer to K that 
exceeds K's allocable share of the liability is tested to determine 
whether an exception under Sec.  1.707-4 applies. Because $10,000 of 
the payment to K is a reasonable guaranteed payment for capital 
under Sec.  1.707-4(a)(1)(ii), the $10,000 transfer will not be 
treated as part of a sale by K of property Z to the partnership 
under Sec.  1.707-3, unless the facts and circumstances establish 
that the transfer is not a guaranteed payment for capital but is 
part of a sale.
    Example 12. Treatment of debt-financed transfers of 
consideration by partnership made pursuant to plan. (i) O transfers 
property X, and P transfers property Y, to partnership OP in 
exchange for equal interests therein on June 1, 2014. On October 1, 
2014, the partnership incurs two liabilities: Liability 1 of $8,000 
and Liability 2 of $4,000. On December 15, 2014, the partnership 
transfers $2,000 to each of O and P pursuant to a plan. The 
transfers made to O and P on December 15, 2014 are allocable under 
Sec.  1.163-8T to the proceeds of either Liability 1 or Liability 2. 
Assume that the liabilities incurred on October 1, 2014 are each a 
recourse liability of the partnership under Sec.  1.752-2 and that 
O's and P's share of Liability 1 is $4,000 each and Liability 2 is 
$2,000 each on December 15, 2014.
    (ii) Because the partnership transferred pursuant to a plan a 
portion of the proceeds of the two liabilities to O and P, paragraph 
(b)(1) of this section is applied by treating Liability 1 and 
Liability 2 as a single $12,000 liability. Pursuant to paragraph 
(b)(2)(ii)(A) of this section, each partner's allocable share of the 
$12,000 liability equals the amount obtained by multiplying the sum 
of the partner's share of Liability 1 and Liability 2 ($6,000) 
($4,000 for Liability 1 plus $2,000 for Liability 2) by the fraction 
obtained by dividing--
    (A) The amount of the liability that is allocable to the 
distribution to O and P pursuant to the plan ($4,000); by
    (B) The total amount of such liability ($12,000).
    (iii) Therefore, O's and P's allocable share of the $12,000 
liability is $2,000 each. Accordingly, because a portion of the 
proceeds of the $12,000 liability are allocable under Sec.  1.163-8T 
to the $2,000 transfer made to each of O and P within 90 days of 
incurring the liability, and the $2,000 transfer does not exceed O 
or P's $2,000 allocable share of that liability, each is required to 
take into account $0 of the $2,000 transfer for purposes of this 
section and Sec.  1.707-3. Under these facts, no part of the 
transfers to O and P will be treated as part of a sale of property X 
by O or property Y by P.
    Example 13. Treatment of debt-financed transfers of 
consideration by partnership with liability allocated according to 
partners' liquidation value percentages. (i) X transfers property A, 
which has a fair market value of $90,000 and an adjusted tax basis 
of $5,000,

[[Page 4835]]

to partnership XY in exchange for an interest therein on March 29, 
2014. At the time of the contribution, partnership XY's only asset 
is property B with a fair market value of $120,000 and adjusted tax 
basis of $70,000. On March 30, 2014, the partnership incurs a 
liability of $30,000. On March 31, 2014, the partnership transfers 
$30,000 to X, and $30,000 of this transfer is allocable under the 
rules of Sec.  1.163-8T to proceeds of the partnership liability 
incurred on March 30, 2014. Assume that, under section 752 and the 
corresponding regulations, the $30,000 liability incurred on March 
30, 2014 is a nonrecourse liability of the partnership and that 
partnership XY allocates its excess nonrecourse liabilities under 
Sec.  1.752-3(a)(3) in accordance with the partners' liquidation 
value percentages as defined in Sec.  1.752-3(a)(3).
    (ii) Under paragraph (a)(2)(ii) of this section, X's share of 
partnership XY's $30,000 nonrecourse liability is determined by 
applying the same percentages used to determine X's share of XY's 
excess nonrecourse liabilities under Sec.  1.752-3(a)(3). Because 
the distribution to X is an event described in Sec.  1.704-
1(b)(2)(iv)(f)(5), X's liquidation value percentage must be 
redetermined under Sec.  1.752-3(a)(3) as of March 31, 2014, 
irrespective of whether the capital accounts of the partners of 
partnership XY are adjusted under Sec.  1.704-1(b)(2)(iv)(f). X's 
liquidation value percentage is 33.3% ((X's liquidation value of 
$60,000 immediately after the distribution) divided by (partnership 
XY's aggregate liquidation value of $180,000 immediately after the 
distribution)). Accordingly, under paragraph (a)(2)(ii) of this 
section, X's share of the $30,000 liability is $10,000 on March 31, 
2014.
    (iii) Because the transfer made to X on March 31, 2014 is 
allocable under Sec.  1.163-8T to proceeds of a partnership 
liability that was incurred by the partnership within 90 days of 
that transfer, X is required to take the transfer into account in 
applying the rules of this section and Sec.  1.707-3 only to the 
extent that the amount of the transfer exceeds X's allocable share 
of the liability used to fund the transfer. X's allocable share of 
the $30,000 liability used to fund the $30,000 transfer to X is 
$10,000 (X's share of the liability ($10,000) multiplied by the 
fraction obtained by dividing--
    (A) The amount of the liability that is allocable to the 
distribution to X ($30,000); by
    (B) The total amount of such liability ($30,000)).
    (iv) Therefore, X is required to take into account $20,000 of 
the $30,000 partnership transfer to X for purposes of this section 
and Sec.  1.707-3.
* * * * *
0
Par. 6. Section 1.707-8 is amended by revising paragraph (a) to read as 
follows:


Sec.  1.707-8  Disclosure of certain information.

    (a) In general. The disclosure referred to in Sec.  1.707-3(c)(2) 
(regarding certain transfers made within two years of each other), 
Sec. Sec.  1.707-5(a)(3)(ii) and 1.707-5(b)(2)(iii)(B) (regarding the 
reduction of a liability presumed to be anticipated), Sec.  1.707-
5(a)(7)(ii) (regarding a liability incurred within two years prior to a 
transfer of property), and Sec.  1.707-6(c) (relating to transfers of 
property from a partnership to a partner in situations analogous to 
those listed above) is to be made in accordance with paragraph (b) of 
this section.
* * * * *
    Par. 7. Section 1.707-9 is amended by revising paragraphs (a)(1) 
and (b) to read as follows:


Sec.  1.707-9  Effective dates and transitional rules.

    (a) * * *
    (1) In general. Except as provided in paragraph (a)(3) of this 
section, Sec. Sec.  1.707-3 through 1.707-5 apply to any transaction 
with respect to which all transfers occur on or after [effective date 
of final rule] and Sec.  1.707-6 applies to any transaction with 
respect to which all transfers that are part of a sale of an item of 
property occur after April 24, 1991. For any transaction with respect 
to which all transfers that are part of a sale of an item of property 
occur after April 24, 1991, but before [effective date of final rule], 
Sec. Sec.  1.707-3 through 1.707-5 as contained in 26 CFR edition 
revised April 1, 2013 (TD 8439) apply.
* * * * *
    (b) Section 1.707-8 disclosure of certain information. The 
disclosure provisions described in Sec.  1.707-8 apply to any 
transaction with respect to which all transfers occur on or after 
[effective date of final rule]. Otherwise, for any transaction with 
respect to which all transfers that are part of a sale of property 
occur after September 30, 1992, but before [effective date of final 
rule], Sec.  1.707-8 as contained in 26 CFR edition revised April 1, 
2013 (TD 8439) applies.
* * * * *
0
Par. 8. Section 1.752-0 is amended by:
0
a. Removing the entries for Sec. Sec.  1.752-2(b)(5) and (b)(6).
0
b. Revising the entries for Sec.  1.752-2(j)(3) and (j)(4).
0
c. Adding entries for Sec.  1.752-2(k), (k)(1), (2), (3), (4), (5), and 
(6).
0
d. Adding an entry for Sec.  1.752-2(l).
0
e. Redesignating the entry for Sec.  1.752-3(b) as Sec.  1.752-3(c) and 
adding a new entry for Sec.  1.752-3(b).
0
f. Adding an entry for Sec.  1.752-3(d).
    The revisions and additions read as follows:


Sec.  1.752-0  Table of contents.

* * * * *


Sec.  1.752-2  Partner's share of recourse liabilities.

* * * * *
    (j) * * *
    (3) Plan to circumvent or avoid the obligation.
    (4) Arrangements intended to avoid certain requirements of 
paragraph (b).
* * * * *
    (k) Effect of a disregarded entity.
    (1) In general.
    (2) Net value of a disregarded entity.
    (3) Multiple liabilities.
    (4) Reduction in net value of a disregarded entity.
    (5) Information to be provided by the owner of a disregarded 
entity.
    (6) Examples.
    (l) Effective/applicability dates.
    (1) In general.
    (2) Transitional rules.


Sec.  1.752-3  Partner's share of nonrecourse liabilities.

* * * * *
    (b) Allocation of a single nonrecourse liability among multiple 
properties.
    (c) Examples.
    (d) Effective/applicability dates.
* * * * *
    Par. 9. Section 1.752-2 is amended by:
0
a. Revising the first sentence in paragraph (b)(1).
0
b. Revising paragraph (b)(3).
0
c. Removing paragraphs (b)(5) and (b)(6).
0
d. Adding a sentence at the end of paragraph (f), revising Example 3, 
reserving Example 9, and adding new Examples 10, 11, and 12.
0
e. Revising paragraph (j)(4).
0
f. Revising the first sentence of paragraph (k)(1).
0
g. Revising paragraphs (k)(2)(i)(A) and (l).
    The revisions and additions read as follows:


Sec.  1.752-2  Partner's share of recourse liabilities.

* * * * *
    (b) * * *
    (1) * * * Except as otherwise provided in this section, a partner 
bears the economic risk of loss for a partnership liability to the 
extent that, if the partnership constructively liquidated, the partner 
or related person would be obligated to make a payment to any person 
(or a contribution to the partnership) because that liability becomes 
due and payable and the partner or related person would not be entitled 
to reimbursement from another person. * * *
* * * * *
    (3) Obligations recognized--(i) In general. The determination of 
the extent

[[Page 4836]]

to which a partner or related person has an obligation to make a 
payment under paragraph (b)(1) of this section is based on the facts 
and circumstances at the time of the determination. Notwithstanding the 
prior sentence, a payment obligation will not be recognized if it fails 
to satisfy paragraphs (b)(3)(ii) and (iii) of this section. All 
statutory and contractual obligations relating to the partnership 
liability are taken into account for purposes of applying this section, 
including:
    (A) Contractual obligations outside the partnership agreement such 
as guarantees, indemnifications, reimbursement agreements, and other 
obligations running directly to creditors, to other partners, or to the 
partnership;
    (B) Obligations to the partnership that are imposed by the 
partnership agreement, including the obligation to make a capital 
contribution and to restore a deficit capital account upon liquidation 
of the partnership; and
    (C) Payment obligations (whether in the form of direct remittances 
to another partner or a contribution to the partnership) imposed by 
state law, including the governing state partnership statute.
    (ii) Recognition requirements. An obligation of a partner or 
related person to make a payment with respect to a partnership 
liability described under paragraph (b)(3)(i)(A) or (B) of this section 
is not recognized under paragraph (b)(3) of this section unless all of 
the requirements of this paragraph (b)(3)(ii)(A) through (G) are 
satisfied. To the extent that an obligation of a partner or related 
person to make a payment with respect to a partnership liability is not 
recognized under paragraph (b)(3) of this section, paragraph (b) of 
this section is applied as if the obligation did not exist.
    (A) The partner or related person is--
    (1) Required to maintain a commercially reasonable net worth 
throughout the term of the payment obligation; or
    (2) Subject to commercially reasonable contractual restrictions on 
transfers of assets for inadequate consideration.
    (B) The partner or related person is required periodically to 
provide commercially reasonable documentation regarding the partner's 
or related person's financial condition.
    (C) The term of the payment obligation does not end prior to the 
term of the partnership liability.
    (D) The payment obligation does not require that the primary 
obligor or any other obligor with respect to the partnership liability 
directly or indirectly hold money or other liquid assets in an amount 
that exceeds the reasonable needs of such obligor.
    (E) The partner or related person received arm's length 
consideration for assuming the payment obligation.
    (F) In the case of a guarantee or similar arrangement, the partner 
or related person is or would be liable up to the full amount of such 
partner's or related person's payment obligation if, and to the extent 
that, any amount of the partnership liability is not otherwise 
satisfied. For purposes of this paragraph (b)(3)(ii)(F), the terms of a 
guarantee or similar arrangement will be treated as modified by any 
right of indemnity, reimbursement, or similar arrangement regardless of 
whether that arrangement would be recognized under paragraph (b)(3) of 
this section. However, the preceding sentence does not apply to a right 
of proportionate contribution running between partners or related 
persons who are co-obligors with respect to a payment obligation for 
which each of them is jointly and severally liable.
    (G) In the case of an indemnity, reimbursement agreement, or 
similar arrangement, the partner or related person is or would be 
liable up to the full amount of such partner's or related person's 
payment obligation if, and to the extent that, any amount of the 
indemnitee's or other benefitted party's payment obligation is 
satisfied. The indemnity, reimbursement agreement, or similar 
arrangement only satisfies this paragraph (b)(3)(ii)(G) if, before 
taking into account the indemnity, reimbursement agreement, or similar 
arrangement, the indemnitee's or other benefitted party's payment 
obligation is recognized under paragraph (b)(3) of this section or 
would be recognized under paragraph (b)(3) of this section if such 
person were a partner or related person. For purposes of this paragraph 
(b)(3)(ii)(G), the terms of an indemnity, reimbursement agreement, or 
similar arrangement will be treated as modified by any further right of 
indemnity, reimbursement, or similar arrangement regardless of whether 
that further arrangement would be recognized under paragraph (b)(3) of 
this section. However, the preceding sentence does not apply to a right 
of proportionate contribution running between partners or related 
persons who are co-obligors with respect to a payment obligation for 
which each of them is jointly and severally liable.
    (iii) Satisfaction of obligation--(A) In general. Except as 
provided in paragraph (b)(3)(iii)(B) of this section, for purposes of 
determining the extent to which a partner or related person has a 
payment obligation or bears the economic risk of loss for a partnership 
liability under paragraph (b)(1) of this section, it is assumed that 
such partner or related person who has an obligation to make a payment 
actually performs its obligation, irrespective of its actual net value, 
unless the facts and circumstances indicate a plan to circumvent or 
avoid the obligation. See paragraph (j) of this section.
    (B) Net value requirement. In determining the extent to which a 
partner or related person other than an individual or a decedent's 
estate bears the economic risk of loss under paragraph (b)(1) of this 
section for a partnership liability other than a trade payable, a 
payment obligation is recognized only to the extent of the net value of 
the partner or related person as of the allocation date (as defined in 
paragraph (k)(2)(iv) of this section) that is allocated to the 
partnership liability. A partner or related person's net value is 
determined under the rules of paragraph (k) of this section. This 
paragraph (b)(3)(iii)(B) applies to a payment obligation of a partner 
or related person that is disregarded as an entity separate from its 
owner under sections 856(i) or 1361(b)(3) or Sec. Sec.  301.7701-1 
through 301.7701-3 of this chapter or is a trust to which subpart E, 
part I, subchapter J, chapter 1 of the Code applies (a disregarded 
entity), even if the owner of the disregarded entity is an individual 
or a decedent's estate. A partner or related person that is not a 
disregarded entity is treated as a disregarded entity for purposes of 
determining net value of the partner or related person under paragraph 
(k) of this section.
    (C) Information to be provided regarding net value. A partner that 
may be treated as bearing the economic risk of loss for a partnership 
liability based upon an obligation under paragraph (b)(1) of this 
section (a Sec.  1.752-2(b)(1) payment obligation) of a person, 
including the partner, other than an individual or a decedent's estate, 
must provide information to the partnership as to that person's net 
value that is appropriately allocable to the partnership's liabilities 
on a timely basis.
* * * * *
    (f) Examples. * * * For purposes of Examples 1 through 7, unless 
otherwise provided, assume that any obligation of a partner or related 
person to make a payment with respect to the partnership liability 
satisfies the requirements under paragraphs (b)(3)(ii), (b)(3)(iii), 
and (k) of this section where applicable.
* * * * *

[[Page 4837]]

    Example 3. Guarantee by limited partner; partner satisfaction of 
obligation. E and F form a limited partnership. E, the general 
partner, contributes $2,000 and F, the limited partner, contributes 
$8,000 in cash to the partnership. E and F are both business 
entities (as defined in Sec.  301.7701-2(a) of this chapter). The 
partnership agreement allocates losses 20% to E and 80% to F until 
F's capital account is reduced to zero, after which all losses are 
allocated to E. The partnership purchases depreciable property for 
$25,000 using its $10,000 cash and a $15,000 recourse loan from a 
bank. E's net value, determined under paragraphs (k)(2) through 
(k)(4) of this section, at all times exceeds the $15,000 loan 
amount, but F guarantees payment of the $15,000 loan to the extent 
the loan remains unpaid after the bank has exhausted its remedies 
against the partnership (including causing E to make any 
contributions required of a general partner under state law). In a 
constructive liquidation, the $15,000 liability becomes due and 
payable. All of the partnership's assets, including the depreciable 
property, are deemed to be worthless. The depreciable property is 
deemed sold for a value of zero. Capital accounts are adjusted to 
reflect the loss on the hypothetical disposition, as follows:

------------------------------------------------------------------------
                                                       E           F
------------------------------------------------------------------------
Initial contribution............................      $2,000      $8,000
Loss on hypothetical sale.......................    (17,000)     (8,000)
                                                 -----------------------
                                                   ($15,000)         -0-
------------------------------------------------------------------------

    E, as a general partner, would be obligated by operation of law 
to make a net contribution to the partnership of $15,000. Under 
paragraph (b)(3)(iii)(B) of this section, E has net value to satisfy 
its payment obligation as of the allocation date. Because E has net 
value to the extent of its obligation, it is assumed that F would 
not have to satisfy F's guarantee. The $15,000 mortgage is treated 
as a recourse liability because one or more partners bear the 
economic risk of loss. E's share of the liability is $15,000, and 
F's share is zero.
* * * * *
    Example 9.  [Reserved]
* * * * *
    Example 10. Guarantee of first and last dollars. (i) A, B, and C 
are equal members of limited liability company, ABC, that is treated 
as a partnership for federal tax purposes. ABC borrows $1,000 from 
Bank. A guarantees payment of up to $300 of the ABC liability if any 
amount of the full $1,000 liability is not recovered by Bank. B 
guarantees payment of up to $200, but only if the Bank otherwise 
recovers less than $200. Both A and B waive their rights of 
contribution against each other. A's and B's guarantees satisfy the 
requirements set forth in paragraphs (b)(3)(ii)(A) through (E) and 
paragraph (b)(3)(iii) of this section.
    (ii) Because A is obligated to pay up to $300 if, and to the 
extent that, any amount of the $1,000 partnership liability is not 
recovered by Bank, A's guarantee satisfies the requirement under 
paragraph (b)(3)(ii)(F) of this section. Therefore, A's payment 
obligation is recognized under paragraph (b)(3) of this section. The 
amount of A's economic risk of loss under paragraph (a)(1) of this 
section is $300. However, because B is obligated to pay up to $200 
only if and to the extent that the Bank otherwise recovers less than 
$200 of the $1,000 partnership liability, B's guarantee does not 
satisfy the requirement under paragraph (b)(3)(ii)(F) of this 
section and B's payment obligation is not recognized. Therefore, B 
bears no economic risk of loss under paragraph (a)(1) of this 
section for ABC's liability. As a result, $300 of the liability is 
allocated to A under paragraph (a)(1) of this section and the 
remaining $700 liability is allocated to A, B, and C under Sec.  
1.752-3.
    Example 11. Indemnification of guarantees. (i) The facts are the 
same as in Example 10, except that, in addition, C agrees to 
indemnify A up to $50 that A pays with respect to its guarantee, and 
agrees to indemnify B fully with respect to its guarantee. C's 
indemnity satisfies the requirements set forth in paragraphs 
(b)(3)(ii)(A) through (E) and paragraph (b)(3)(iii) of this section.
    (ii) The determination of whether C's indemnity satisfies the 
requirement under paragraph (b)(3)(ii)(G) of this section is made 
without regard to whether C's indemnity itself causes A's guarantee 
not to be recognized. Because A's obligation would be recognized but 
for the effect of C's indemnity and C is obligated to pay A up to 
the full amount of C's indemnity if A pays any amount on its 
guarantee of ABC's liability, C's indemnity of A's guarantee 
satisfies the requirement under paragraph (b)(3)(ii)(G) of this 
section. The amount of C's economic risk of loss under paragraph 
(a)(1) of this section for its indemnity of A's guarantee is $50.
    (iii) Because C's indemnity of A's guarantee satisfies the 
requirement under paragraph (b)(3)(ii)(G) of this section, it is 
treated as modifying A's guarantee such that A is treated as liable 
for $250 only to the extent any amount beyond $50 of the partnership 
liability is not satisfied. Thus, A is not liable if, and to the 
extent, any amount of the partnership liability is not otherwise 
satisfied, and, as a result, A's guarantee is not recognized under 
paragraph (b)(3)(ii)(F) of this section. Therefore, A bears no 
economic risk of loss under paragraph (a)(1) of this section for 
ABC's liability.
    (iv) Because B's obligation is not recognized under paragraph 
(b)(3) of this section, C's indemnity of B's guarantee does not 
satisfy the requirement under paragraph (b)(3)(ii)(G) of this 
section, and C's payment obligation to B is not recognized. 
Therefore, C bears no economic risk of loss under paragraph (a)(1) 
of this section for its indemnity of B's guarantee. As a result, $50 
of the liability is allocated to C under paragraph (a)(1) of this 
section and the remaining $950 liability is allocated to A, B, and C 
under Sec.  1.752-3.
    Example 12. Partial guarantee of partnership liability. (i) A, 
B, and C are equal members of limited liability company, ABC, that 
is treated as a partnership for federal tax purposes. ABC borrows 
$1,000 from Bank. A guarantees payment of 25 percent of each dollar 
of the $1,000 liability that is not recovered by Bank. A's guarantee 
satisfies the requirements set forth in paragraphs (b)(3)(ii)(A) 
through (E) and paragraph (b)(3)(iii) of this section.
    (ii) If $250 of the $1,000 partnership liability is not 
recovered by Bank, A is only obligated to pay $62.50 ($250 x .25) 
pursuant to the terms of the guarantee. Because A is not obligated 
to pay up to the full amount of its payment obligation ($250) to the 
extent that $250 is not recovered by Bank, A's guarantee does not 
satisfy the requirement under paragraph (b)(3)(ii)(F) of this 
section, and A's payment obligation is not recognized. As a result, 
the ABC liability is allocated to A, B, and C under Sec.  1.752-3.
* * * * *
    (j) * * *
    (4) Arrangements intended to avoid certain requirements of 
paragraph (b). An obligation of a partner or related person to make a 
payment with respect to a partnership liability is not recognized under 
paragraph (b) of this section if the facts and circumstances indicate 
that the partnership liability is part of a plan or arrangement 
involving the use of tiered partnerships, intermediaries, or similar 
arrangements to convert a single liability into more than one liability 
with a principal purpose of circumventing the rules of paragraphs 
(b)(3)(ii)(F) and (G) of this section.
* * * * *
    (k) * * *
    (1) * * * In determining the extent to which a partner bears the 
economic risk of loss for a partnership liability other than a trade 
payable, an obligation under paragraph (b)(1) of this section (Sec.  
1.752-2(b)(1) payment obligation) of a business entity that is 
disregarded as an entity separate from its owner under sections 856(i) 
or 1361(b)(3) or Sec. Sec.  301.7701-1 through Sec. Sec.  301.7701-3 of 
this chapter or a trust to which subpart E, part I, subchapter J, 
chapter 1 of the Code applies (disregarded entity) is taken into 
account only to the extent of the net value of the disregarded entity 
as of the allocation date (as defined in paragraph (k)(2)(iv) of this 
section) that is allocated to the partnership liability as determined 
under the rules of this paragraph (k). * * *
    (2) * * *
    (i) * * *
    (A) The fair market value of all assets owned by the disregarded 
entity that may be subject to creditors' claims under local law 
(including the disregarded entity's enforceable rights to contributions 
from its owner, and the fair market value of an interest in any 
partnership, but excluding the disregarded entity's direct or indirect 
interest in the partnership for which the net value is being determined 
and the

[[Page 4838]]

net fair market value of property pledged to secure a liability of the 
partnership under paragraph (h)(1) of this section); less
* * * * *
    (l) Effective/applicability dates--(1) In general. Paragraph (a) 
and paragraphs (h)(3) and (k) of this section apply to liabilities 
incurred or assumed by a partnership on or after October 11, 2006, 
other than liabilities incurred or assumed by a partnership pursuant to 
a written binding contract in effect prior to that date. The rules 
applicable to liabilities incurred or assumed (or pursuant to a written 
binding contract in effect) prior to October 11, 2006, are contained in 
Sec.  1.752-2 in effect prior to October 11, 2006, (see 26 CFR part 1 
revised as of April 1, 2006). Paragraphs (b)(1) first sentence, (b)(3), 
(f), (f) Examples 3, 10, 11, and 12, (j)(4), (k)(1) first sentence, and 
(k)(2)(i)(A) of this section apply to liabilities incurred or assumed 
by a partnership and to payment obligations imposed or undertaken with 
respect to a partnership liability on or after [effective date of final 
rule], other than liabilities incurred or assumed by a partnership and 
payment obligations imposed or undertaken pursuant to a written binding 
contract in effect prior to that date.
    (2) Transitional rules--(i) In general. If a partner has a share of 
a recourse partnership liability under paragraph (b) of this section 
immediately prior to [effective date of final rule] (Transition 
Partner), the partnership (Transition Partnership) may choose not to 
apply paragraphs (b)(1) first sentence, (b)(3), (f), (f) Examples 3, 
10, 11, and 12, (j)(4), (k)(1) first sentence, and (k)(2)(i)(A) of this 
section to the extent the amount of the Transition Partner's share of 
liabilities under paragraph (b) of this section immediately prior to 
the effective date exceeds the amount of the Transition Partner's 
adjusted basis in its partnership interest as determined under Sec.  
1.705-1 at such time (Grandfathered Amount). The Transition Partnership 
may continue to apply the rules under Sec.  1.752-2 in effect prior to 
[effective date of final rule], with respect to a Transition Partner 
for liabilities described in paragraph (b) of this section to the 
extent of the Transition Partner's adjusted Grandfathered Amount for 
the seven-year period beginning [effective date of final rule]. A 
Transition Partner's Grandfathered Amount is reduced (not below zero), 
but never increased, by--
    (A) Upon the sale of any property by the Transition Partnership, an 
amount equal to the excess of any tax gain allocated to the Transition 
Partner by the Transition Partnership (including amounts allocated 
under section 704(c) and applicable regulations) over the product of 
the total amount realized by the Transition Partnership from the 
property sale multiplied by the Transition Partner's liquidation value 
percentage as determined under Sec.  1.752-3(a)(3), and
    (B) An amount equal to any decrease in the Transition Partner's 
share of liabilities to which the rules of this paragraph (l)(2)(i) 
apply, other than by operation of paragraph (l)(2)(i)(A) of this 
section.
    (ii) Special rules--(A) Ownership changes in Transition Partner. A 
Transition Partner that is a partnership, S corporation, or disregarded 
entity ceases to qualify as a Transition Partner if the direct or 
indirect ownership of that Transition Partner changes by 50 percent or 
more.
    (B) Section 708(b)(1)(B) terminations. The termination of a 
Transition Partnership under section 708(b)(1)(B) and applicable 
regulations does not affect the Grandfathered Amount of a Transition 
Partner that remains a partner in the new partnership (as described in 
Sec.  1.708-1(b)(4)), and the new partnership is treated as a 
continuation of the Transition Partnership for purposes of this 
paragraph (l)(2).
0
Par. 10. Section 1.752-3 is amended by:
0
a. Removing the third and fourth sentences in paragraph (a)(3) and 
adding four new sentences in their place.
0
b. Revising Example 2 in paragraph (c).
0
c. Adding paragraph (d).
    The revisions and additions read as follows:


Sec.  1.752-3  Partner's share of nonrecourse liabilities.

    (a) * * *
    (3) * * * The partnership agreement may specify the partners' 
interests in partnership profits for purposes of allocating excess 
nonrecourse liabilities provided the interests so specified are in 
accordance with the partners' liquidation value percentages. A 
partner's liquidation value percentage, which is determined upon the 
formation of a partnership and redetermined upon any event described in 
Sec.  1.704-1(b)(2)(iv)(f)(5), irrespective of whether the capital 
accounts of the partners are adjusted under Sec.  1.704-1(b)(2)(iv)(f), 
is the ratio (expressed as a percentage) of the liquidation value of 
the partner's interest in the partnership divided by the aggregate 
liquidation value of all of the partners' interests in the partnership. 
Any change in the partners' shares of partnership liabilities as a 
result of an event described in Sec.  1.704-1(b)(2)(iv)(f)(5) is taken 
into account in determining the tax consequences of the event that gave 
rise to such change. For purposes of this paragraph (a)(3), the 
liquidation value of a partner's interest in a partnership is the 
amount of cash the partner would receive with respect to the interest 
if, immediately after the formation of the partnership or the 
occurrence of an event described in Sec.  1.704-1(b)(2)(iv)(f)(5), as 
the case may be, the partnership sold all of its assets for cash equal 
to the fair market value of such assets (taking into account section 
7701(g)), satisfied all of its liabilities (other than those described 
in Sec.  1.752-7), paid an unrelated third party to assume all of its 
Sec.  1.752-7 liabilities in a fully taxable transaction, and then 
liquidated. * * *
    (c) * * *
    Example 2. Excess nonrecourse liabilities allocated according to 
partners' liquidation value percentages. (i) On January 1, 2012, X 
and Y each contribute $100 to a limited liability company classified 
as a partnership for U.S. tax purposes (XY) in exchange for equal 
interests in XY. XY's organizing agreement provides that it will 
maintain members' capital accounts in accordance with section 704 
and the regulations thereunder, and will make liquidating 
distributions in accordance with positive capital account balances. 
XY has a calendar year taxable year. On the same day, XY borrows $50 
from a person unrelated to either X or Y. Under the rules of this 
section, the liability is a nonrecourse liability. XY purchases Land 
A for $50 and Land B for $200. The partners agree to allocate excess 
nonrecourse liabilities in accordance with the partners' liquidation 
value percentages as defined in paragraph (a)(3) of this section.
    (ii) Under paragraph (a)(3) of this section, the liquidation 
value percentage for each of partners X and Y is 50% ((each 
partner's liquidation value immediately after the formation of $100) 
divided by (XY's aggregate liquidation value immediately after the 
formation of $200)). Therefore, X and Y each has a $25 share of the 
$50 liability and each is treated as contributing $25 to XY under 
section 752(a).
    (iii) On September 1, 2015, XY owns the following assets: (1) 
Land A with a fair market value of $40 and an adjusted tax basis of 
$50; (2) Land B with a fair market value of $800 and an adjusted tax 
basis of $200; and (3) Land C with a fair market value of $400 and 
an adjusted tax basis of $390. The outstanding principal on the 
partnership liability is $40. Thus, X and Y each own an interest in 
XY with a fair market value of $600 and an adjusted tax basis of 
$320. The partners continue to agree to allocate excess nonrecourse 
liabilities in accordance with the partners' liquidation value 
percentages as defined in paragraph (a)(3) of this section. On 
September 1, 2015, XY distributes Land C to X. Assume XY has no 
items of income, gain,

[[Page 4839]]

loss, deduction, or credit in its taxable year ending December 31, 
2015.
    (iv) The distribution of Land C to X is an event described in 
Sec.  1.704-1(b)(2)(iv)(f)(5) and, thus, under paragraph (a)(3) of 
this section, X's liquidation value percentage must be redetermined 
under paragraph (a)(3) of this section as of September 1, 2015, 
irrespective of whether the capital accounts of the partners of XY 
are adjusted under Sec.  1.704-1(b)(2)(iv)(f). X's liquidation value 
percentage is 25% ((X's liquidation value immediately after the 
distribution of $200) divided by (XY's aggregate liquidation value 
immediately after the distribution of $800)). Accordingly, X's share 
of the $40 liability is reduced from $20 to $10 on September 1, 
2015, while Y's share of the liability is increased from $20 to $30. 
Thus, X is treated as receiving a distribution of $10 from XY under 
section 752(b), and Y is treated as contributing $10 to XY under 
section 752(a). Because the distribution of $10 to X does not exceed 
X's $320 adjusted basis in its interest in XY, X recognizes no gain. 
Pursuant to section 732(a)(2), X's basis in Land C is $310.
* * * * *
    (d) Effective/applicability dates. The third, fourth, fifth, and 
sixth sentences of paragraph (a)(3) of this section and paragraph (c) 
Example 2 of this section apply to liabilities that are incurred or 
assumed by a partnership on or after [effective date of final rule], 
other than liabilities incurred or assumed by a partnership pursuant to 
a written binding contract in effect prior to that date.
0
Par. 11. Section 1.752-5 is amended by revising the second and third 
sentences of paragraph (a) to read as follows:


Sec.  1.752-5  Effective dates and transitional rules.

    (a) * * * However, Sec.  1.752-3(a)(3) seventh, eighth, and ninth 
sentences, (b), and (c) Example 3, do not apply to any liability 
incurred or assumed by a partnership prior to October 31, 2000. 
Nevertheless, Sec.  1.752-3(a)(3) seventh, eighth, and ninth sentences, 
(b), and (c) Example 3, may be relied upon for any liability incurred 
or assumed by a partnership prior to October 31, 2000 for federal 
taxable years ending on or after October 31, 2000. * * *

John Dalrymple,
Deputy Commissioner for Services and Enforcement.
[FR Doc. 2014-01637 Filed 1-29-14; 8:45 am]
BILLING CODE 4830-01-P