In October 2019, Treasury issued final regulations that address how a partnership should allocate its liabilities under IRC Section 752. (See PwC’s prior Insight, Final rules address disguised sales, bottom-dollar payment obligations.)
A partnership generally allocates recourse liabilities to the partners that ultimately bear the economic obligation to pay the liability if the partnership becomes worthless. Prior to the final regulations, many alternative investment funds structured as limited partnerships had interpreted this rule to treat 100% of the partnership liabilities as recourse to the general partner (regardless of the GP’s assets or net value). The final regulations, however, now require partnerships to determine if a creditor would have a “commercially reasonable” expectation that the partner will have the ability to pay the obligation (if the partnership is unable) in order to treat the liability as recourse.
Observation: Many partners historically have relied upon their allocation of partnership liabilities in order to increase their tax basis in the partnership. Tax practitioners should revisit partners’ allocable share of partnership liabilities in light of these new rules.
The final regulations apply to partnership liabilities incurred on or after October 9, 2019 (other than any liabilities incurred under a binding contract in effect before that date). Liabilities incurred prior to October 9 are grandfathered under the old rules (as described in the prior Insight linked above).
The final regulations could significantly alter the treatment, allocation, and reporting of liabilities for the 2019 tax year. Funds and their managers should review any liabilities incurred after October 9, 2019 to determine the appropriate allocation among partners in the fund.
Asset Management Tax Leader, PwC US