7739 / What liabilities are included in a partner’s adjusted basis in a partnership interest before January 30, 1989, and partner loans and guarantees before March 1, 1984?

A partner’s basis includes the partner’s share of partnership liabilities.¹ However, accrued but unpaid expenses and accounts payable of a cash basis partnership are not treated as partnership liabilities for this purpose.² Where none of the partners have any personal liability with respect to a partnership liability (nonrecourse debt), all partners (including limited partners) share the liability in the same proportion as they share profits. Prior regulations gave as an example of such a liability a mortgage on real estate acquired by the partnership without the assumption by the partnership or any of the partners of any liability on the mortgage. Partnership recourse liabilities are shared by the partners in the same ratio that they share losses, but a limited partner’s share of partnership recourse liability may not exceed the difference between the limited partner’s actual contribution and the total contribution to the partnership that he or she is obligated to make under the partnership agreement.³

Because limited partners who are not obligated to make additional contributions can include in basis a share of a partnership liability only if it is nonrecourse (no partner has personal liability with respect to the obligation), the question has come up whether a partner who guarantees an otherwise nonrecourse partnership loan has “personal liability” within the meaning of the regulations. The IRS takes the position that a general partner’s guarantee makes the partner personally liable to the extent the value of the property securing the loan is insufficient to cover the amount due and, as a consequence, the guaranteed loan is one for which a partner is personally liable. Therefore, limited partners not committed to make future contributions are not able to include a share of such an obligation in their basis.⁴

Guaranteeing a partnership recourse obligation does not increase a limited partner’s obligation to make additional contributions “under the partnership agreement.” Therefore, a limited partner may not increase his or her share of partnership recourse liability by making such a guarantee.⁵ Similarly, a limited partner’s agreement to indemnify a general partner for certain recourse liabilities does not increase the limited partner’s basis in the partnership interest by a share of partnership recourse liabilities because it does not increase the limited partner’s obligation “to the partnership.”⁶ Where a partnership obligation is partly nonrecourse and partly recourse, a limited partner may include in basis the limited partner’s share of the portion that is nonrecourse. (For example, a note provides that to the extent property securing a loan of $350X is inadequate, the general partner is liable up to $150X; a limited partner may share the $200X nonrecourse liability in the same proportion he or she shares profits.)⁷

If the likelihood the limited partner will have to make additional contributions is contingent or indefinite, the partner cannot share partnership recourse liabilities. The IRS determined that the obligation to make additional contributions represented by letters of credit contributed by limited partners was too contingent and indefinite where the principal on a partnership loan, which was assumed by limited partners and secured by the letters of credit, was not due for four years. The Service noted that the partnership could have generated sufficient income to pay the loan through income from operations or sale of assets prior to the due date and that the likelihood of a default in the tax year which would cause the loan to be immediately payable was remote since interest payments were not due until the next taxable year.⁸

To increase basis, the loan must be a bona fide loan. Such an increase has been denied where the “loan” was determined to be an investment or capital contribution to the venture. A nonrecourse loan from a general partner to limited partners or to the partnership is a contribution to the capital of the partnership by the general partner, not a loan; therefore, the amount increases the basis of the partnership interest of the general partner, but not of the limited partners.⁹ A nonrecourse loan by an unrelated third party to a partnership engaged in exploring for oil and gas, secured by property of limited value but convertible into an interest in partnership profits, was ruled not a bona fide loan, but capital at risk in the venture.¹⁰

Increase in basis has been denied where the obligation was so speculative as to be considered a contingent obligation. For example, the IRS ruled that a partnership nonrecourse note payable only out of partnership cash flow was not includable in basis because payment was so speculative that the liability was a contingent liability. The partnership business involved a commercially untested new process and no realistic predictions could be made about the partnership’s net cash flow.¹¹

A nonrecourse note to be paid only if there was production from oil wells was found to be too uncertain and indefinite an obligation to be treated as a partnership liability.¹²

The Service will not recognize a sham liability entered into for the purpose of increasing the basis of property and, as a result, the allowable depreciation, or enlarging a partner’s basis against which the partner may deduct partnership losses. A nonrecourse note did not represent genuine indebtedness because the principal amount of the note greatly exceeded the value of the property purchased by it and securing it.¹³