Tax Benefit from Leveraged Partnerships Shut Down By New IRS Regulations

Tax Law Update


On October 5, 2016, the IRS and Treasury released a package of new regulations under Code sections 707 and 752 designed to curtail the use of debt to reduce tax on the contribution of appreciated assets to leveraged partnerships. In recent years, such structures have been commonly used in drop-down capitalizations of joint ventures and publicly-traded partnerships (usually referred to as “MLPs”), frequently in high dollar value transactions that allowed cash from the partnership to be distributed to the corporate sponsors with minimal gain recognition. Under the new rules, partnership debt which would previously have been allocated to the corporate sponsor to increase its basis and decrease its gain recognition is much less likely to be so allocable.

The package of regulations, which includes final, temporary and proposed regulations provides new rules in the following areas: (1) with respect to the disguised sale of assets through use of a partnership, all debt is effectively treated as nonrecourse, meaning that a partner contributing assets cannot protect against gain recognition except to the extent of the partner’s percentage share of partnership profits; (2) the exception for preformation expenses which reduced taxable gain recognition on the contribution of appreciated assets to a partnership has been narrowed; (3) the rules regarding the allocation of debt among the partners when a partner guarantees the partnership’s debt have been changed in a number of respects, including the exclusion of bottom-dollar guarantees and the application of a facts and circumstances test to determine when and how a guarantee of debt affects the allocation of debt among the partners.

Download the complete article by partners Peter Connors and Barbara de Marigny for an in-depth look at the new regulations.