Tax consequences of liquidating a partnership

But the IRS took the position that the taxpayer partnership’s debt may be nonrecourse and, therefore, the partnership may not have COD income; but a capital gain, to the extent the discharged debt exceeded their basis in the collateral property. In reaching its position, the IRS relied upon referenced the IRC Section 752 definitions of recourse and nonrecourse debt, it did not apply these definitions to the case – instead, it used a “facts and circumstances” test.

The court concluded that the debt must be nonrecourse to the partnership, as there were no other assets beyond the collateral to satisfy the debt.

The IRC Section 704b regulations present this possibility but the Code section does not define this classification of liability.

Case law, however, defines nonrecourse debt as debt in which the creditor’s right of recovery is limited to the collateral, or the particular asset securing the liability.

The partnership taxpayer borrowed funds to purchase the collateral property, which secured the debt.

This is the essence of the rule applied by the tax court in .Rather, the lender bears the risk of loss, when a partnership takes out a nonrecourse loan. 201525010 relied on the definitions under IRC Section 752, in reaching the conclusion that the partnership taxpayer had a recourse loan, when a lender discharged a partnership loan and foreclosed upon the collateral property.The partnership taxpayer was a California Limited Liability Company; or more specifically, a special purpose entity (SPE), created for the sole purpose of purchasing a specified piece of real property (“collateral property”) for its development and sale.In an event of default, the lender cannot pursue the borrower if the debt is nonrecourse debt, because the borrower is not personally liable for the debt.By contrast, a creditor’s right of recovery, for a recourse debt, extends beyond the collateral, to all assets of the borrower, because the borrower is personally liable.

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Although the IRS did not provide a definitive answer to whether the partnership taxpayer’s loan was recourse or nonrecourse in its memorandum, it pointed to a couple of key facts that suggested the loan may be nonrecourse to the partnership taxpayer: First, the partnership taxpayer was an SPE and, therefore, had only one asset, which was the collateral property, to which the lender was limited to, upon default of the loan (the lender had no access to any other partnership assets that were unrelated to the collateral property).

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