Final Regulations on Partnership Recourse Liabilities

Michael Schindler, Caleb Egli
| 1/16/2025
Final Regulations on Partnership Recourse Liabilities
In summary
  • Final Section 752 regulations on allocating recourse partnership liabilities offer some much-needed clarity.
  • The rules provide guidance for determining a partner’s share of partnership recourse liabilities and can be applied retroactively.
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The IRS and U.S. Department of the Treasury have issued final regulations under Section 752 regarding the allocation of partnership recourse liabilities. The regulations were first proposed in 2013 and have been finalized with certain modifications based on comments received.

The final regulations generally are effective for liabilities incurred or assumed by a partnership after Dec. 2, 2024; however, a partnership may elect to apply the regulations to all liabilities incurred or assumed by the partnership (even liabilities incurred or assumed before Dec. 2, 2024) for returns filed on or after Dec. 2, 2024, provided that they are consistently applied.

Crowe observation

It is unusual for Treasury and the IRS to finalize proposed regulations that have been outstanding for so long (in this case, 11 years) without reproposing them, a point specifically addressed in the preamble to the regulations. The generally favorable nature of these final regulations and the generous retroactive application rules might have led to the decision to finalize them without reproposing them.

Background

Section 752 generally provides rules for determining a partner’s share of partnership liabilities. When a partnership liability is allocated to a partner, the resulting increase in that partner’s basis affects their ability to receive distributions and claim tax deductions and losses.

The Section 752 regulations address liabilities based on whether they are recourse or nonrecourse liabilities. A partnership liability is recourse to the extent any partner or a related person bears the economic risk of loss for the liability. Generally, a partner bears the economic risk of loss to the extent that the partner (or someone related to the partner) would be obligated to make a payment to a creditor out of a nonpartnership asset if all the assets become worthless and the liability comes due.

Conversely, to the extent no partner or related person bears the economic risk of loss with respect to a partnership liability, the liability is nonrecourse.

Final regulations

The final regulations deal with only a handful of specific rules regarding recourse liabilities. Following are some highlights of the new regulations.

Overlapping economic risk of loss (EROL): The regulations adopt a proportionality rule to determine how partnership liability is allocated when multiple partners bear EROL for the same liability. Under this rule, each partner’s share of the liability is based on the ratio of the partner’s EROL to the total EROL borne by all partners for that liability.

Tiered partnerships: The regulations provide clearer guidance on how lower-tier partnerships must allocate liabilities when a partner of an upper-tier partnership (UTP) is also a partner of a lower-tier partnership (LTP) and bears EROL for the LTP’s liability. The regulations provide that the LTP is required to allocate the liability directly to the partner in the LTP.

Related-party constructive ownership: Generally, the regulations modify the constructive ownership rules under Section 1.752-4 to disregard the application of the Sections 267(c)(1) and 1563(e)(2) related-party rules to determine EROL in certain situations.

Exception to the related-party rules: The final regulations provide that if a person holds a partnership interest (directly or indirectly through another partnership) and has a direct EROL in a partnership liability (through either being a lender or having a payment obligation), that person is treated as unrelated to all other direct and indirect partners. This rule would implement the result in the Tax Court case IPO II v. Commissioner, which held that the related-partner exception turns off the relationship between partners and that the entirety of a partnership’s liability is allocated to the partner that directly bore the EROL for the partnership’s liability despite the fact that a nonpartner related to the partner also had EROL.

Person related to multiple partners: The regulations provide that if a nonpartner has a direct EROL in a partnership liability and is related to two or more partners in the partnership, the partners related to the nonpartner bear the EROL with respect to the partnership liability in accordance with their interests in partnership profits.

Ordering rule: The regulations adopt an ordering rule to clarify the interaction between the various EROL provisions as follows:

  • First, determine if any partner directly bears EROL and apply the related-partner exception.
  • Second, assess the EROL borne by partners related to a person directly bearing EROL.
  • Finally, apply the proportionality rule when multiple partners’ EROL exceeds the partnership liability.

Looking ahead

While the guidance is welcome because it resolves some long-standing ambiguities regarding allocation of partnership recourse liabilities, it creates some uncertainty for partnerships with respect to existing and future liabilities. The final regulations allow retroactive application of the final regulations and provide that, if adopted, they should be applied consistently. In addition, retroactive application of the regulations could have consequences for both current and former partners. Therefore, partnerships should consult with their tax advisers to evaluate whether to apply the final regulations to all partnership liabilities or to only those liabilities incurred or assumed by the partnership on or after Dec. 2, 2024.

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Michael Schindler
Michael Schindler
Principal, Washington National Tax
Caleb Egli Headshot
Caleb Egli
Managing Director, Washington National Tax

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