Effect of Partnership Liabilities — 1225 Publ 541 (PDF)

A partner’s basis in a partnership interest includes the partner’s share of a partnership liability only if, and to the extent that, the liability:

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Creates or increases the partnership’s basis in any of its assets;
Gives rise to a current deduction to the partnership; or
Is a nondeductible, noncapital expense of the partnership.

The term “assets” in (1) includes capitalized items allocable to future periods, such as organization expenses.

A partner’s share of accrued but unpaid expenses or accounts payable of a cash basis partnership is not included in the adjusted basis of the partner’s interest in the partnership.

Partner’s basis increased. If a partner’s share of partnership liabilities increases or a partner’s individual liabilities increase because they assume partnership liabilities, this increase is treated as a contribution of money by the partner to the partnership.

Partner’s basis decreased. If a partner’s share of partnership liabilities decreases or a partner’s individual liabilities decrease because the partnership assumes their individual liabilities, this decrease is treated as a distribution of money to the partner by the partnership.

Assumption of liability. Generally, a partner or related person is considered to assume a partnership liability only to the extent that:

They’re personally liable for it,
The creditor knows that the liability was assumed by the partner or related person,
The creditor can demand payment from the partner or related person, and
No other partner or person related to another partner will bear the economic risk of loss on that liability immediately after the assumption.

Related person. Related persons, for these purposes, includes all the following.

An individual and their spouse, ancestors, and lineal descendants.
An individual and a corporation if the individual directly or indirectly owns 80% or more in value of the outstanding stock of the corporation.
Two corporations that are members of the same controlled group.
A grantor and a fiduciary of any trust.
Fiduciaries of two separate trusts if the same person is a grantor of both trusts.
A fiduciary and a beneficiary of the same trust.
A fiduciary and a beneficiary of two separate trusts if the same person is a grantor of both trusts.
A fiduciary of a trust and a corporation if the trust or the grantor of the trust directly or indirectly owns 80% or more in value of the outstanding stock of the corporation.
A person and a tax-exempt educational or charitable organization controlled directly or indirectly by the person or by members of the person’s family.
A corporation and a partnership if the same persons own 80% or more in value of the outstanding stock of the corporation and 80% or more of the capital or profits interest in the partnership.
Two S corporations or an S corporation and a C corporation if the same persons own 80% or more in value of the outstanding stock of each corporation.
An executor and a beneficiary of an estate.
A partnership and a person owning, directly or indirectly, 80% or more of the capital or profits interest in the partnership.
Two partnerships if the same persons directly or indirectly own 80% or more of the capital or profits interests.

Property subject to a liability. If property contributed to a partnership by a partner or distributed by the partnership to a partner is subject to a liability, the transferee is treated as having assumed the liability to the extent it doesn’t exceed the FMV of the property.

Partner’s share of recourse liabilities. A partnership liability is a recourse liability to the extent that any partner or a related person, defined earlier under Related person , has an economic risk of loss for that liability. A partner’s share of a recourse liability equals their economic risk of loss for that liability. A partner has an economic risk of loss if that partner or a related person would be obligated (whether by agreement or law) to make a net payment to the creditor or a contribution to the partnership with respect to the liability if the partnership were constructively liquidated. A partner who is the creditor for a liability that would otherwise be a nonrecourse liability of the partnership has an economic risk of loss in that liability.

Constructive liquidation. Generally, in a constructive liquidation, the following events are treated as occurring at the same time.

All partnership liabilities become payable in full.
All of the partnership’s assets have a value of zero, except for property contributed to secure a liability.
All property is disposed of by the partnership in a fully taxable transaction for no consideration except relief from liabilities for which the creditor’s right to reimbursement is limited solely to one or more assets of the partnership.
All items of income, gain, loss, or deduction are allocated to the partners.
The partnership liquidates.

Example. Juan and Teresa form a cash basis general partnership with cash contributions of $20,000 each. Under the partnership agreement, they share all partnership profits and losses equally. The partnership borrows $60,000 and purchases depreciable business equipment.

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This debt is included in the partners’ basis in the partnership because incurring it creates an additional $60,000 of basis in the partnership’s depreciable property.

If neither partner has an economic risk of loss in the liability, it is a nonrecourse liability. Each partner’s basis would include their share of the liability, $30,000.

If Teresa is required to pay the creditor if the partnership defaults, she has an economic risk of loss in the liability. Her basis in the partnership would be $80,000 ($20,000 + $60,000), while Juan’s basis would be $20,000.

Limited partner. A limited partner generally has no obligation to contribute additional capital to the partnership and therefore doesn’t have an economic risk of loss in partnership recourse liabilities. Thus, absent some other factor, such as the guarantee of a partnership liability by the limited partner or the limited partner making the loan to the partnership, a limited partner generally doesn’t have a share of partnership recourse liabilities.

Partner’s share of nonrecourse liabilities. A partnership liability is a nonrecourse liability if no partner or related person has an economic risk of loss for that liability. A partner’s share of nonrecourse liabilities is generally proportionate to their share of partnership profits. However, this rule may not apply if the partnership has taken deductions attributable to nonrecourse liabilities or the partnership holds property that was contributed by a partner.

More information. For more information on the effect of partnership liabilities, including rules for limited partners and examples, see Regulations sections 1.752-1 through 1.752-5.