Debt Distribution partnership distributions include “unrealized receivables” and “substantially appreciated inventory items,” which likely encompasses more assets than may appear upon first glance. In fact, it is rare that an operating partnership would not hold some Hot Assets. Unrealized receivables is broadly defined to include depreciation recapture under IRC §1245 and IRC §1250, and although inventory must be substantially appreciated (120 percent of its tax basis) to be considered a Hot Asset, the definition includes all assets not considered a capital asset or an IRC §1231 asset if sold by the partnership. In the event a disproportionate distribution of Hot Asset to a partner occurs, IRC §751 requires a hypothetical sale. This section of the IRC takes the approach that a partners receiving a distribution initially receives a distribution of all assets proportionate to his or her partnership interest followed by a sale of Hot Assets back to the partnership in exchange for the assets actually received. It should be noted that the current Regulations and the IRC seem to disagree about the appropriate method used to calculate the value of the hot assets deemed to be distributed by the partnership.
partnership debt, which is part of a partner's tax basis in the partnership, is allocated under IRC §752. Under this Code section, debt is allocated differently depending on whether the debt is recourse or non-recourse to the partners of the partnership.
IRC Section 752 Debt Allocations Partnership debt, which is part of a partner’s tax basis in the partnership, is allocated under IRC §752. Under this Code section, debt is allocated differently depending on whether the debt is recourse or non-recourse to the partners of the partnership. Recourse debt is allocated to the partners based on who economically bears the loss if all assets of the partnership were to theoretically become worthless and the partner had to cover the debt. Recourse debt can be present when there is a general partner with unlimited liability or
when there is a personal guarantee of a debt by a limited partner or member of an LLC. Member non-recourse debt, which is debt loaned by a member of family member to an LLC, is also treated as recourse debt because the lending member or his or her family bears the economic burden if the partnership was unable to pay the debt. The allocation of non-recourse debt can be significantly more complex. Non-recourse debt is allocated among the partners based on a three tier approach. First, nonrecourse debt is allocated to partners who have minimum gain, which is the amount of income a partner will be charged back in future periods due to deductions taken on non-recourse debt; second, based on the amount of taxable gain that would be allocated under IRC §704(c) if the partnership disposed of property that is encumbered by non-recourse debt; and third, based on the partners’ share of partnership profits or a significant item of partnership profits. Many of these debt allocation rules can be very complicated and are not discussed here in depth but are mentioned to illustrate that there can be several deferent instances when debt allocated to a partner may be reduced.
Deemed Distributions and Hot Assets IRC Section 752(b) states that “any decrease in a partner’s share of liabilities of a partnership, or any decrease in a partner’s individual liabilities by reason of assumption by the partnership of such liabilities, shall be considered as a distribution of money by the partnership to the partner.” This statute makes it clear that a decrease in liability is a deemed distribution of cash to the partner. These deemed distributions are subject to the IRC §751(b) Hot Asset rules, which means that a partner may have to recognize IRC §751 income even if no actual distribution of cash or property has occurred. This is because a partner with a decrease in allocated debt would be deemed to have received a distribution of all cash and not a share of a partnership’s Hot Assets in proportion to his or her partnership interest. Under the rules of IRC §751 the partner would be treated as having received Hot assets (instead of all cash) by the partnership in proportion to his or her partnership interest followed by a sale back to the partnership in exchange for the deemed cash proceeds.
the journal entry | July 2015
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