Earlier this year, the IRS issued Chief Counsel Advice 201606027 (February 5, 2016) concluding that, for purposes of the basis and at-risk limitations, an LLC member's guarantee of entity-level nonrecourse debt conditioned upon the occurrence of one or more "bad boy" carve-outs caused such debt to be classified as recourse debt with respect to the guarantor. Consequently, the LLC debt would be allocated to the guaranteeing member under the Section 752 debt allocation regulations and such debt would no longer meet the definition of "qualified nonrecourse financing" under Section 465(b)(6)(B). As you might expect, this CCA was not well received by the real estate industry given the prevalence of bad boy guarantees in lending transactions.
On April 15, 2016, the IRS released Advice Memorandum 2016-001 reaching very different conclusions than those in the February CCA. In the Advice Memorandum, the IRS concluded that, "unless the facts and circumstances indicate otherwise, a typical 'nonrecourse carve-out' provision that allows the borrower or the guarantor to avoid committing the enumerated bad act will not cause an otherwise nonrecourse liability to be treated as recourse for purposes of Section 752 . . . until such time as the contingency actually occurs". With respect to the at-risk limitation in Section 465, the IRS concluded that a "bad boy" guarantee will not cause the nonrecourse debt to fail to be classified as "qualified nonrecourse financing".
Although the IRS has not formally withdrawn the CCA as of this time, AM 2016-001 effectively reversed the conclusions in the earlier CCA, which was welcome news to the real estate industry.
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