The IRS Office of Chief Counsel issued AM2016-001, clarifying the IRS’ position that certain contingent guarantees of nonrecourse debt, also known as “bad-boy guarantees,” normally do not create partner basis or at-risk amounts for the partner until an identified event occurs to trigger the guarantee. The guidance appears to be issued to correct IRS Chief Counsel Advice CCA 201606027, which concluded the bad-boy guarantee would convert an otherwise nonrecourse liability shared by all partners into a recourse liability allocated to only the guarantor.
In CCA 201606027, a managing member of a real estate partnership made bad-boy guarantees to a third-party lender when obtaining financing for property renovations and operations. In the CCA, the IRS determined that this guarantee was sufficient to treat the debt as a recourse liability to the managing member even though no events had occurred to trigger the guarantee. Because the debt was treated as a recourse liability of the managing member, the partnership’s losses were allocated to the managing member, and none were allocated to the other partners. This allocation was contrary to the generally held interpretation of contingent guarantees, which is that the debt should not have been allocated to the member until an event had occurred to trigger the contingent guarantee. If the bad-boy guarantee did not result in recourse debt allocated to the managing member, the debt would have been treated as qualified nonrecourse real estate debt, and all partners would have shared in the losses of the partnership.
Under AM2016-001, the following bad-boy guarantees will not result in the debt being treated as recourse debt to the guarantor. Circumstances other than those listed here must be analyzed on a case-by-case basis:
- The borrower fails to obtain the lender’s consent before obtaining subordinate financing or transfer of the secured property.
- The borrower files a voluntary bankruptcy petition.
- Any person in control of the borrower files an involuntary bankruptcy petition against the borrower.
- Any person in control of the borrower solicits other creditors of the borrower to file an involuntary bankruptcy petition against the borrower.
- The borrower consents to or otherwise acquiesces to or joins in an involuntary bankruptcy or insolvency proceeding.
- Any person in control of the borrower consents to the appointment of a receiver or custodian of assets.
- The borrower makes an assignment for the benefit of creditors or admits in writing or in any legal proceeding that it is insolvent or unable to pay its debts as they come due.
Although CCA 201606027 was not withdrawn, the IRS appears to have corrected its decision in AM2016-001 and concluded that the bad-boy guarantees listed there will not change the status of nonrecourse debts to recourse until a trigger event occurs. Partnerships will need to analyze bad-boy guarantees not listed in AM2016-001 to determine how the liabilities should be allocated on the partnership return.