Monday, October 16, 2006

ALLOCATION OF LIABILITIES TO A PARTNER WHEN PARTNER INVESTS THROUGH A DISREGARDED ENTITY

A little background is needed to understand the impact of recently released Treasury Regulations relating to the tax basis of an interest in a partnership by a partner.

A. Partners in a partnership may receive additional tax basis in their partnership interests based on their allocable share of liabilities of the partnership itself. That is, if the partnership borrows money, a portion of that borrowing can be allocated to the partners and increase the income tax basis of the partners in the partnership. Tax basis can be relevant for many purposes - for example, basis is needed to be able to deduct losses arising from the partnership.

B. Very generally, a partner will be allocated so much of a partnership liability to the extent that the partner bears the ultimate risk of loss relating to the repayment of the partnership obligation.

C. What happens if the partner doesn't own an interest in the partnership directly, but holds its interest through a "disregarded entity" and the owner of the disregarded entity is not responsible for the liabilities of the disregarded entity? Does the owner of the disregarded entity get to increase its basis in the partnership (since the owner is treated as the deemed partner because the disregarded entity is disregarded for income tax purposes) to the full extent that it could if it was in the shoes of the disregarded entity? This is the subject of the recent Regulations.

The Regulations do allow the partner to stand in the shoes of the disregarded entity for purposes of calculating its share of the liabilities of the partnership to determine its adjusted basis as deemed partner. HOWEVER, the amount of maximum amount of partnership liabilities that can be taken into account for this purpose is limited to the net value of the disregarded entity.

The Regulations provide a specific definition for "net value" for use in applying these rules.

T.D. 9289, 10/10/2006 ; Reg. § 1.704-2 , Reg. § 1.752-2.

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