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Allocation of Debt and Advances: Qualified
Nonrecourse Financing. On February 13,
2001, the Service issued the following as LTR 200120020.
AUTHOR: Internal Revenue Service
GEOGRAPHIC: United States
INDEX: partnerships, liabilities; at-risk rules
REFERENCES:
Subject Area: Partnership taxation; REITs and REMICs and REMICs
Industry Group: Real estate
TEXT:
Release Date: FEBRUARY 13, 2001
Index Numbers: 465.00-00, 752.00-00
Release Date: 5/18/2001
Date: February 13, 2001
Refer Reply To: CC:PSI:2 - PLR-104379-00
Dear * * *
[1] This is in reply to your letter dated January 31, 2000, and
subsequent correspondence,
submitted on behalf of P1, requesting certain rulings regarding P1's proposal to issue unsecured
debt to refinance certain outstanding debt obligations.
[2] The information provided indicates that P1 is a State W
limited partnership. X, a
State Y real estate investment trust, is the managing general partner of P1. X owns in excess of
90% of the units (the "Units") of P1; the balance of the Units are owned by individuals subject to
section 465 of the Internal Revenue Code. P1 primarily acquires, owns and operates multifamily
residential properties, directly and through subsidiary partnerships (including limited liability
companies). The aggregate gross fair market value of the property owned by P1 that is neither
real property nor property incidental to the activity of holding real property will be less than 10
percent of the aggregate gross fair market value of all assets of P1 (including assets held
through subsidiary partnerships).
[3] P1 has acquired properties subject to secured
nonrecourse debt. P1 also has available
an unsecured line of credit (Line of Credit). P1 is able to draw upon the Line of Credit from time
to time to obtain capital to meet its various needs subject to continued compliance with certain
financial and other covenants. The Line of Credit is a general obligation of P1.
[4] P1 anticipates drawing advances under the Line of Credit
that will be applied to
refinance mortgage debt assumed by P1 in connection with the acquisition of properties in
exchange for Units in P1 (or mortgage debt that was later incurred to refinance mortgage debt
that was assumed by P1 at the time of contribution). P1 owns these properties either directly or
through subsidiary partnerships (including limited liability companies) in which it owns
substantially all of the economic interests and controls the general partner (or is, or controls, the
managing member). To the extent that P1 draws advances under the Line of Credit for this
purpose, the proceeds of the particular advances under the Line of Credit used for such purpose
will be traced, under the principles set forth in section 1.163-8T of the Income Tax Regulations
to
the repayment of the specific mortgage debt that is refinanced. The Line of Credit also is used
currently to fund other acquisition and development activity of P1.
[5] Under the Line of Credit, as it is currently in effect, the
lenders would have recourse
against X in the event that a default under the Line of Credit were to occur. P1 and X intend to
pursue an amendment of the Line of Credit so that neither X nor any of the partners of P1 have
any personal liability for repayment of the Line of Credit. Therefore, the liabilities will become
nonrecourse to the partners of P1.
[6] In addition, P1 anticipates that it will issue unsecured
debt (the "Unsecured Debt")
that is not recourse to any partner of P1 or a subsidiary, related person, or any of the assets of
any partner or related person. P1intends that the Unsecured Debt will be a general obligation of
P1, such that, in the case of a default, the holders of the Unsecured Debt will have a claim
against all of the assets of P1, rather than against specific assets of P1.
[7] It is anticipated that the Unsecured Debt will be issued to
refinance the mortgage debt
assumed by P1 in connection with the acquisitions of properties (or mortgage debt that was later
incurred to refinance mortgage debt that was assumed by P1 at the time of contribution). It is
also anticipated that the Unsecured Debt will be used to fund acquisition and development
activity of P1. The proceeds of the Unsecured Debt will be traced, under the principles set forth
in section 1.163-8T to the repayment of the specific mortgage debt that is refinanced.
[8] P1 represents that the Unsecured Debt will provide that
none of the partners of P1
and no related person to any partner (as defined in section 1.752-4(b)) will have any liability for
the repayment of the Unsecured Debt.
[9] P1 represents that neither the Unsecured Debt nor the
Line of Credit will be
convertible into an equity interest in P1.
[10] P1 further represents that to the best of its knowledge
the purchasers of the
Unsecured Debt will be qualified purchasers that satisfy the requirements of section
49(a)(1)(D)(iv) until the earlier of (1) two years after the Unsecured Debt is issued, or (2) a
registration statement with respect to the Unsecured Debt is declared effective under the
Securities Act of 1933, and that during such time period, substantially all the benefits and
burdens of ownership of the Unsecured Debt will inure to those purchasers.
[11] P1 also represents that each of the lenders of the Line of
Credit is a qualified person
within the meaning of section 49(a)(1)(D)(iv).
[12] Section 752(a) provides that any increase in a partner's
share of liabilities of a
partnership, or any increase in a partner's individual liabilities by reason of the assumption by the
partner of partnership liabilities is considered a contribution of money by the partner to the
partnership. Similarly, under section 752(b), any decrease in a partner's share of liabilities of a
partnership, or any decrease in a partner's individual liabilities by reason of the assumption by
the partnership of the individual
liabilities is considered a distribution of money to the partner by the partnership.
[13] Section 752(c) provides that, for purposes of section
752, a liability to which
property is subject will, to the extent of the fair market value of such property, be considered as
a liability of the owner of the property.
[14] Section 1.752-1(a)(1) provides that a partnership
liability is a recourse liability to
the extent that any partner or related person bears the economic risk of loss for that liability
under section 1.752-2.
[15] Section 1.752-2(b) provides that except as otherwise
provided in section
1.752- 2(b), a partner bears the economic risk of loss for a partnershipliability to the extent that,
if the partnership constructively liquidated, the partner or related person would be obligated to
make a payment to any person (or a contribution to the partnership) because that liability
becomes due and payable and the partner or related person would not be entitled to
reimbursement from another partner or person that is a related person to another partner.
[16] Section 1.752-2(b)(3) provides that the determination of
the extent to which a
partner or related person has an obligation to make a payment under section 1.752(b)(1) is based
on the facts and circumstances at the time of the determination. All statutory and contractual
obligations relating to the partnership liability are taken into account for purposes of applying
section 1.752-2, including contractual obligations outside the partnership agreement such as
guarantees, indemnifications, reimbursement agreements, and other obligations running directly
to creditors or to other partners, or to the partnership.
[17] Section 1.752-3(a)(2) provides that the partner's share
of the nonrecourse liabilities
of the partnership includes the amount of any taxable gain that would be allocated to the partner
under section 704(c) (or in the same manner as section 704(c) in connection with a revaluation
of partnership property) if the partnership disposed of (in a taxable transaction) all partnership
property subject to one or more nonrecourse liabilities of the partnership in full satisfaction of
liabilities and for no other consideration. The gain a partner would be allocated under the
hypothetical sale in section 1.752- 3(a)(2) is referred to as section 704(c) minimum gain.
[18] Section 704(c) minimum gain is the amount of gain that
a partner would
receive under section 704(c) from a hypothetical sale solely in satisfaction of the nonrecourse
liabilities encumbering partnership property. With limited exceptions (see section 1.704-
3(e)(2)), section 704(c) gain is calculated on a property-by-property basis. If more than one item
of partnership property is subject to a single nonrecourse liability, the partnership must allocate
the nonrecourse liability among the individual items of partnership property before the
partnership can calculate each partner's share of section 704(c) minimum gain. The portion of
the nonrecourse liability allocated to each item of partnership property is then treated as a
separate loan under section
1.752-3(a)(2).
[19] Section 465 limits the deductions for losses for any
taxable year for an activity to the
extent of the total amount for which the taxpayer is at risk for the activity at the close of the
taxable year. For partnerships, the section 465 at risk limitation applies at the partner level.
[20] Under section 465(c)(3), the activity engaged in by the
taxpayer in carrying on a
trade or business of holding real property is subject to the at risk limitation of section 465.
[21] Section 465(b)(2)(A) provides that a taxpayer's at risk
amount includes amounts
borrowed for use in an activity to the extent that the taxpayer is personally liable for the
repayment of the borrowed amounts. Section 465(b)(6), however, allows a taxpayer to treat
qualified nonrecourse financing as an amount at risk even though the taxpayer is not personally
liable for the repayment of the financing. Section 465(b)(6)(A) provides that notwithstanding
any other provision of section 465(b), in the case of an activity of holding real property, a
taxpayer is considered at risk for the taxpayer's share of any "qualified nonrecourse financing"
that is secured by real property used in the activity of holding real property.
[22] Section 465(b)(6)(B) defines qualified nonrecourse
financing to mean any
financing (i) that is borrowed by the taxpayer for the activity of holding real property, (ii) that is
borrowed by the taxpayer from a qualified person or represents a loan from any federal, state, or
local government or instrumentality thereof, or is guaranteed by any federal, state, or local
government, (iii) except to the extent provided in regulations, for which no person is personally
liable for repayment, and (iv) that is not convertible debt.
[23] Section 465(b)(6)(C) provides that in the case of a
partnership, a partner's share of
any qualified nonrecourse financing of such partnership shall be determined on the basis of the
partner's share of liabilities of such partnership incurred in connection with such financing
(within the meaning of section 752).
[24] Section 1.465-27(b)(4) provides that the personal
liability of any partnership for
repayment of a financing is disregarded and the financing is treated as qualified nonrecourse
financing secured by real property if (i) the only persons personally liable to repay the financing
are partnerships; (ii) each partnership with personal liability holds only property described in
section 1.465-27(b)(2)(i); and (iii) in exercising its remedies to collect on the financing in a
default or default-like situation, the lender may proceed only against property that is described in
section 1.465- 27(b)(2)(i) and that is held by the partnership or partnerships. Section
1.465-27(b)(5) provides that principles similar to those found in section 1.465-27(b)(4) apply in
determining whether a financing of an entity disregarded for federal tax purposes is treated as
qualified nonrecourse financing secured by real property.
[25] Based on the information provided and the
representations made we conclude as
follows:
1. For purposes of section 752, P1 may allocate the
Unsecured Debt and each advance
under the Line of Credit among its multiple properties (including P1's proportional share of the
properties owned by the P1 subsidiaries that qualify as partnerships for federal income tax
purposes) in any amounts determined by it; provided, however, that the aggregate allocation of
the Unsecured Debt and the outstanding advances under the Line of Credit to each property may
not exceed the lesser of (a) the fair market value of the property, or (b) the amount of debt
(previously allocated to the property) repaid with the proceeds of the Unsecured Debt and the
outstanding advances under the Line of Credit.
2. For purposes of section 1.752-3(a)(2), the Unsecured Debt
and the outstanding advances under the Line of Credit will be treated as nonrecourse liabilities
secured by P1's assets (including P1's proportional share of the properties owned by P1's
subsidiaries that qualify as partnerships for federal income tax purposes [sic].
3. For purposes of section 752, P1 may allocate reductions in
the amount of the
Unsecured Debt among its multiple properties (including P1's proportional share of the
properties owned by P1's subsidiaries that qualify as partnerships for federal income tax
purposes) in the same manner and in the same proportion as the Unsecured Debt is initially
allocated.
4. For purposes of section 752, P1 may designate each
advance under the Line of Credit
as a separate loan (with all advances on a particular date treated as a single advance for this
purpose) and may designate repayments under the Line of Credit as repayments of one or more
specified advances thereunder, with reductions in each advance under the Line of Credit
allocated among P1's multiple properties (including P1's proportional share of the properties
owned by P1's subsidiaries that qualify as partnerships for federal income tax purposes) in the
same manner and in the same proportion as such advance is initially allocated.
5. For purposes of section 465(b)(6)(A), the Unsecured Debt
and the outstanding advances under the Line of Credit will be treated as qualified nonrecourse
financing as to which no person has personal liability and that is considered secured by P1's
assets (including P1's proportional share of the properties owned by the P1 subsidiaries that
qualify as partnerships for federal income tax purposes).
[26] Except as specifically ruled upon above, we express no
opinion on the federal tax consequences of the transactions described above under any other
provisions of the Code. The rulings set forth above regarding the use of the proceeds from the
advances under the Line of Credit are conditioned on the amendment of the Line of Credit
resulting in neither X nor any of the partners of P1 having any liability for repayment of the Line
of Credit. Similarly, the rulings regarding the Unsecured Debt are conditioned on the
representation that no partner of P1 will have any personal liability for the repayment of the
Unsecured Debt. No opinion is expressed or intended as to whether the Line of Credit, as
amended, or the Unsecured Debt will be treated as nonrecourse liabilities. Furthermore, no
opinion is expressed regarding the tax consequences of the conversion of the Line of Credit from
a recourse liability to a nonrecourse liability.
[27] This ruling is directed only to the taxpayers who
requested it. Section 6110(k)(3) of the Code provides that it may not be used or cited as
precedent.
[28] Pursuant to the power of attorney on file with this
office, a copy of this letter is being sent to P1.
Sincerely yours,
J. Thomas Hines
Branch Chief, Branch 2
Office of the Associate Chief Counsel
(Passthroughs and Special Industries)
Enclosures: 2
Copy of this letter
Copy for section 6110 purposes
**************** End of Document ****************
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