ADVANCED
PARTNERSHIP DEBT
ALLOCATIONS
Howard E. Abrams
April/May 2014
BASIC RULES
 Recourse debt is allocated in accordance with risk of loss, usually based
on a hypothetical zero-value sale and liquidation.
 Nonrecourse debt is allocated according to three tiers:
 T1: The minimum gain tier.
 T2: The minimum §704(c) gain tier.
 T3: The residual (profits interests) tier.
 Note: There is no third category of partnership debt. If a debt is partially
recourse and partially nonrecourse, it is treated as two separate debts.
DYNAMIC RECOURSE DEBT: EX. 1
 P and Q each contribute $30 to the PQ general partnership in
exchange for 50% of profits and losses. The partnership borrows $40 on
a fully recourse basis. How is the debt allocated between P and Q?
P
CA
Q
OB
30
CA
30
-50
-20
OB
30
30
-50
---
-20
---
DYNAMIC RECOURSE DEBT: EX. 1
 Putting the debt into the outside bases as the partners share risk of
loss, the books become:
P
CA
Q
OB
30
CA
30
OB
30
20
30
50
30
20
30
50
DYNAMIC RECOURSE DEBT: EX. 1
 Suppose the partnership now distributes $40 of cash to partner P. The
books of the venture become:
P
CA
Q
OB
CA
OB
30
50
30
50
-40
-40
0
0
-10
10
30
50
DYNAMIC RECOURSE DEBT: EX. 1
 But we need to consider the possibility that the distribution works a
reallocation of the debt even though the amount of the debt has not
changed and loss sharing ratios have not changed.
P
CA
Q
OB
-10
CA
10
-30
-40
OB
30
50
-30
---
$0
---
DYNAMIC RECOURSE DEBT: EX 1
 The debt has thus shifted entirely to P, and so the books actually become:
P
CA
Q
OB
-10
CA
10
OB
30
20
-10
30
50
-20
30
Even though the distribution was made only to P, each partner’s
outside basis declines by $20 from $50 to $30.
30
DYNAMIC RECOURSE DEBT: EX. 2
 X contributes $10 while Y and Z each contribute $100 to the XYZ
general partnership. Each partner has a one-third share of profits and
losses. The partnership borrows $60 on a fully recourse basis. A zerovalue sale and liquidation yields a negative capital account only for X,
and so X is allocated all of the debt. The books become:
X
CA
Y
OB
10
CA
10
100
60
10
70
Z
OB
CA
100
100
0
100
100
OB
100
0
100
100
DYNAMIC RECOURSE DEBT: EX. 2
 Suppose the partnership now distributes $70 to X. That reduces the
partnership’s cash down to $200, and a zero-value sale and liquidation
will leave only X with a capital account deficit. Accordingly, all of the
debt remains with X and the books of the venture become:
X
CA
Y
OB
CA
Z
OB
CA
OB
10
70
100
100
100
100
-70
-70
0
0
0
0
-60
0
100
100
100
100
DYNAMIC RECOURSE DEBT: EX. 2
 Now suppose that the partnership distributes $80 to Y. That reduces
the partnership’s cash down to $120. Prior to any reallocation of the
debt, the books become:
X
CA
Y
OB
CA
Z
OB
CA
OB
-60
0
100
100
100
100
0
0
-80
-80
0
0
-60
0
20
20
100
100
DYNAMIC RECOURSE DEBT: EX. 2
 Now let’s do a zero-value sale and liquidation. The partnership has $120
of cash, and assuming that falls in value to zero, each partner is allocated
$40 of the loss. After the zero-value sale, the books of the venture
become:
X
CA
-60
Y
OB
CA
70
Z
OB
20
CA
20
OB
100
-40
-40
-40
-100
-20
60
100
DYNAMIC RECOURSE DEBT: EX. 2
 Because the debt is now allocated 5/6’s to X and 1/6 to Y, one-sixth of
the debt (that is, $10 of the debt) is shifted to Y. But because X’s outside
basis is already zero, that means the cash distribution to Y triggers gain
recognition to X.
X
CA
-60
Y
OB
CA
0
OB
20
(10)
-60
0
Z
CA
20
100
10
20
30
OB
100
0
100
100
NONRECOURSE DEBT: DEPRECIATION
AND BOOK-UPS
 X contributes $1,000,000 and Y contributes Blackacre to XY-LLC, and
Blackacre is worth $1,000,000 with an adjusted basis of $200,000 at the
time of contribution. The partnership borrows $2,000,000 and uses its
cash of $3,000,000 to improve Blackacre. These improvements can be
recovered straight-line over 25 years, and the debt encumbers
Blackacre as well as the improvements. On these figures, the property
has an initial book value of $4,000,000, an adjusted basis of $3,200,000,
and a depreciable basis of $3,000,000. There is depreciation of $120,000
per year for 25 years.
NONRECOURSE DEBT: DEPRECIATION
AND BOOK-UPS
Year
Book Value
Adj. Basis
Dep. Basis
Debt
0
4,000,000
3,200,000
3,000,000
2,000,000
16
2,080,000
1,280,000
1,080,000
2,000,000
17
1,960,000
1,160,000
960,000
2,000,000
20
1,600,000
800,000
600,000
2,000,000
Year
Tier 1
Tier 2
Tier 3
Total
0
0
0
2,000,000
2,000,000
16
0
720,000
1,280,000
2,000,000
17
40,000
800,000
1,160,000
2,000,000
20
400,000
800,000
800,000
2,000,000
RELATED PARTY DEBT RULES
 New related party debt rules were proposed on December 16, 1013, as
Prop. Reg. §1.752-4(b). The following discussion is based on these
proposed regulations.
RELATED PARTY DEBT RULES
P
X
Y
Z
Loan from Z to XY
XY
RELATED PARTY DEBT RULES
P
X
Y
Guarantee
XY
Z
Loan from Z to XY
RELATED PARTY DEBT RULES
P
X
Y
Partial Guarantee
XY
Z
Loan from Z to XY
PARTIAL SALE
 If a partner owning a single partnership interest sells a portion of that
interest, gain is computed by comparing the amount realized on the sale
with a proportionate part of the outside basis.
 The same rule applies if the partner owns multiple interests in the
venture and sells only a part of his ownership interest without regard to
how the interests were acquired (no tracing of basis).
 A partner has a single, unified outside basis.
 A partner has a single, unified capital account.
 After the sale, the capital account of the selling partner that is attributable to the
interest transferred carries over to the transferee.
PARTIAL SALE EXAMPLE
 T joins the P partnership by contributing cash of $5,000 in exchange for
a general partnership interest. Sometime later, T acquires a limited
partnership interest for $7,000. Thereafter, when T’s combined outside
basis in the two interests is $12,000, T sells one of the interests for its
fair market value of $5,000. At the time of the sale, the two interests are
worth $15,000.
 T recognizes a gain of $1,000 on the sale (amount realized of $5,000 less $4,000
allocable portion of adjusted basis).
 Note that it does not matter which interest is sold or whether that particular
interest has increased or decreased in value (no tracing).
PARTIAL SALE: REV. RUL. 84-53
 If a partner sells a portion of his partnership interest and the selling
partner has been allocated a share of the partnership’s liabilities, those
liabilities not shifting as a result of the sale are removed from the selling
partner’s outside basis immediately prior to the sale for the purpose of
computing gain or loss on the sale.
 Suppose X and Y each own half of the XY partnership, and XY owns
Blackacre with inside basis of $400, value of $500, and subject to a debt
of $380. Each partner has an outside basis of $200 including each
partner’s $190 share of the debt.
 Suppose Y sells one-half of her partnership interest to Z for its fair
market value of $30.
REV. RUL. 84-53 EXAMPLE
 If half of Y’s share of the debt shifts to Z, then gain on the sale equals
amount realized of $125 (cash received plus debt shifted) less allocable
portion of adjusted basis of $100, for a gain of $25.
 If no part of the debt shifts, then gain on the sale equals amount realized
of $30 (cash received) less allocable portion of outside basis with debt
removed (that is, one-half of ($200 - $190)) of $5, for a gain of $25.
SALE AFTER DEFT-FINANCED
DISTRIBUTION
 X and Y own 60% and 40% of the profits and losses of XY-LLC. The
partnership owns a single, nondepreciable asset with inside basis and
book value of $0 but current value of $2,000. Each partner has a capital
account and outside basis of $0. The partnership has an election under
section 754 in effect and the partnership agreement provides that
partnership assets will be booked to fair market value whenever
allowable.
 The partnership borrows $500 on a recourse basis, allocable 60% to X
and 40% to Y. The loan proceeds are then distributed in those
percentages.
 Y sells half of her interest to Z for its value of $300.
SALE AFTER DEFT-FINANCED
DISTRIBUTION
X
CA
Y
OB
CA
Z
OB
CA
OB
0
0
0
0
0
0
0
300
0
200
0
0
1200
0
800
0
0
0
-300
-300
-200
-200
0
0
0
0
-300
0
300
300
900
0
300
0
300
300
SALE AFTER DEBT-FINANCED
DISTRIBUTION: SALE OF PROPERTY
X
C
Y
OB
CA
Z
OB
CA
OB
900
0
300
0
300
300
0
1200
0
400
0
400
0
0
0
0
0
-400
0
-300
0
-200
0
0
900
900
300
200
300
300