United States: IRS Issues Final, Temporary And Reproposed Regulations On Disguised Sales And Liability Allocations

The IRS has issued much anticipated guidance concerning disguised sales of property involving partnerships under Section 707 and the determination of whether an obligation is a recourse liability under Section 752.

The guidance package includes final, temporary and proposed regulations and comes nearly three years after the IRS initially proposed regulations in January 2014 that were widely perceived as having the potential to fundamentally change whether certain obligations result in a partner's economic risk of loss (EROL) for a partnership liability under Section 752, which in turn affects a partner's ability to deduct losses and receive tax-free cash distributions from the partnership.

The final regulations (T.D. 9787) address certain rules concerning disguised sales of property to and by a partnership and allocations of excess nonrecourse liabilities to partners for purposes of the disguised sale rules. The temporary regulations (T.D. 9788) address how liabilities are allocated for purposes of Section 707 and when certain obligations are recognized for purposes of determining whether a liability is a recourse partnership liability under Section 752. The proposed regulations (REG-122855-15) incorporate by reference the text of the temporary regulations and offer new reproposed regulations concerning when certain obligations to restore a deficit in a partner's capital account are disregarded under Section 704 and when partnership liabilities are treated as recourse liabilities under Section 752.

Disguised sale provisions

The regulations on disguised sales are intended to address certain deficiencies and ambiguities under Section 707. The existing disguised sale regulations provide several exceptions, such as reimbursements for preformation capital expenditures and debt-financed distributions, as well as the exclusion of certain liabilities (qualified liabilities), or portions thereof, from disguised sale treatment. The final regulations provide modifications to certain of these exceptions.

Under the existing disguised sale rules, transfers of money or other consideration from a partnership to reimburse a partner for certain capital expenditures and costs incurred by the partner are excluded from being treated as part of a disguised sale, subject to certain limitations based on the fair market value (FMV) of property (fair market value limitation) that also involves looking at the partner's adjusted basis in the contributed property (tax basis test). The final regulations provide the following modifications:

  • The FMV limitation and tax basis test would apply on a property-by-property basis. However, the final regulations permit aggregation for small amounts, and where the partner uses a reasonable aggregation method that is consistently applied, and the aggregation of property is not part of a plan of which a principal purpose is to avoid the disguised sale rules.
  • The term "capital expenditures" would be defined to include capital expenditures that the taxpayer previously elected to deduct but to exclude deductible expenses the taxpayer elected to capitalize.
  • The taxpayers would be precluded from "double-dipping" when a preformation capital expenditure is funded with any qualified liability, and economic responsibility for the qualified liability is shifted to another partner upon the assumption of the liability by the partnership.

Another area the temporary and final regulations are intended to address involves leveraged partnership transactions in which the contributing partners or related persons enter into payment obligations that are not genuinely commercial solely to achieve an allocation of the partnership liability to the partner with the objective of avoiding a disguised sale.

The existing disguised sale rules also provide an exception for debt-financed distributions. The existing rules provide that if a partner transferred property to a partnership, and the partnership incurred a liability, the proceeds of which are traceable to that partner, the partner's consideration for disguised sale proceeds would be only to the extent that the money exceeded the partner's allocable share of liabilities. Thus, if the liability were recourse for purposes of Section 752 to the contributing partner, the contributing partner would be effectively shielded from the disguised sale rules.

The temporary regulations now provide that all liabilities are to be treated as nonrecourse under Section 752 for purposes of the disguised sale rules, and they are allocated in the manner in which excess nonrecourse liabilities are allocated under Treas. Reg. Sec. 1.752-3(a)(3), solely in accordance with the partners' allocable share of partnership profits. This represents a major change to the tax impact of liabilities in disguised sale analyses, which will limit significantly the tax usefulness of leveraged distributions in connection with the contribution of property. That is, a distributee partner's guarantee or other similar obligation will no longer cause the debt related to the debt-financed distribution to be allocated solely to such partner, and the cash proceeds in excess of the partner's allocable share of such debt will be treated as received as part of a taxable sale of a portion of the property to the partnership. An exception in the final regulations is provided for small shifts in nonqualified liabilities to prevent pitfalls. Qualified liabilities are not taken into account as consideration in transfers of property treated as a sale when the total amount of all liabilities other than qualified liabilities that the partnership assumes is the lesser of 10% of the total amount of all qualified liabilities the partnership assumes, or $1 million. Additionally, a partner's share of a partnership liability for purposes of the disguised sale rules does not include any amount of the liability for which another partner bears the EROL for the partnership liability.

Another notable change in the final regulations is a "step-in-the-shoes" rule for applying the exception for preformation capital expenditures and for determining whether a liability is a qualified liability when a partner acquires property, assumes a liability or takes property subject to a liability from another person in connection with a nonrecognition transfer under Sections 351, 381(a), 721 or 731.

Recourse liabilities under Section 752 and bottom dollar payment obligations

The temporary regulations restrict "bottom dollar payment obligations" from being recognized as a recourse liability under Treas. Reg. Sec. 1.752-2(b)(3). A bottom dollar payment obligation is a payment obligation other than one in which the partner or related person would be liable for up to the full amount of such partner's payment obligation if any amount of the partnership liability were not satisfied. The temporary regulations provide a few exceptions for certain arrangements:

  • If the partner or related person is liable for at least 90% of the partner's initial payment obligation after taking into account the indemnity, reimbursement agreement or similar arrangement
  • If a maximum amount is placed on the partner's payment obligation
  • If a partner's payment obligation is stated as a fixed percentage of every dollar of the partnership liability to which such obligation relates
  • If there is a right of proportionate contribution running between partners or related persons who are co-obligors with respect to a payment obligation for which each of them is jointly and severally liable

Anti-abuse rule

In response to concerns expressed by commentators with the 2014 proposed regulations, the new proposed regulations replace the seven specific requirements for a partner's payment obligation to be respected with an anti-abuse rule in Treas. Reg. Section 1.752-2(j). The factors in the anti-abuse rule of the new proposed regulations are weighed to determine whether a payment obligation should be respected under Section 752. The list of factors is non-exclusive, and the weight to be given to any particular factor depends on the particular case. The presence or absence of a particular factor is not necessarily indicative of whether or not a payment obligation is recognized for purposes of Section 752.

This departure from the 2014 proposed regulations was made to address concerns that a partner could manipulate contractual arrangements to achieve a federal income tax result that is inconsistent with the economics of the arrangement (e.g., deliberately failing one of the requirements under the 2014 proposed regulations, causing a partnership liability to be treated as nonrecourse under Section 752 even though one partner has true EROL). To combat this, the temporary regulations grant the IRS the authority in an anti-abuse rule to ensure that a liability will be treated as recourse under Section 752 if a partner truly has EROL.

Effective date

The final regulations under Section 707 apply to any transaction with respect to all transfers that occur on or after Oct. 5, 2016. The final regulations under Section 752 apply to liabilities that are incurred by a partnership, that a partnership takes property subject to or that are assumed by a partnership on or after Oct. 5, 2016, unless pursuant to a written binding contract in effect prior to that date.

The temporary regulations under Section 707 apply to any transaction with respect to all transfers that occur on or after Jan. 3, 2017. The temporary regulations under Section 752 apply to liabilities incurred or assumed by a partnership and payment obligations imposed or undertaken with respect to a partnership liability on or after Oct. 5, 2016, unless pursuant to a written binding contract in effect prior to that date. Partnerships may elect to apply all the provisions contained in the Section 752 temporary regulations to all their liabilities as of the first taxable year of the partnership ending on or after Oct. 5, 2016. The temporary regulations provide a seven-year transition relief for any partner whose allocable share of partnership recourse liabilities exceeds its adjusted basis in its partnership interest on the date the temporary regulations are finalized.

The proposed regulations would be effective on the date the final regulations are published and would be applicable to any liabilities incurred or assumed by a partnership and to payment obligations imposed or undertaken with respect to a partnership liability.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

In association with
Related Video
Up-coming Events Search
Font Size:
Mondaq on Twitter
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
Email Address
Company Name
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.


Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.


Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.


A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.


This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.


If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.


This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.