PARTNERSHIPS sometimes play games to get more “outside basis” to one of the partners.
The IRS issued new rules in early August that would make this harder to do. The new rules are merely proposed. They would not take effect until the IRS republishes them in final form.
Many infrastructure projects in the US are owned by limited liability companies that are treated as partnerships for tax purposes.
The outside basis that a partner has in his partnership interest is important because it limits the amount of tax depreciation that the partner can claim from the partnership.
“Outside basis” is the investment that a partner has in his partnership interest. It changes over time. It starts as the sum of what the partner paid for the interest and contributed in capital to the partnership. It increases as the partnership must report taxable income from the partnership. It decreases as the partner is distributed cash.
A partner can include in his outside basis a share of partnership-level debts. Thus, for example, since the project debt is usually borrowed by the project LLC, he can include a share of this project debt.
The rules for how such debt must be shared among partners are complicated. If any of the partners bears the economic risk of loss on the debt, then the entire debt is put into his outside basis. This gives him more room to absorb depreciation from the partnership.
By law in most states, general partners are liable for partnership debts. What some partners have done is to form a special-purpose LLC to be the general partner. They treat the special-purpose LLC as disregarded” for tax purposes. In other words, they take the position that the entity does not exist. It is a shell; it has no assets other than the partnership interest. However, they argue for tax purposes that all
the project debt should be put into the outside basis of the general partner because it is exposed by law on the project debt.
The IRS said in proposed regulations in early August that it will treat a disregarded entity as economically at risk for partnership debts in the future only to the extent of the “net value of the disregarded entity’s assets.”The net value has to be recalculated after certain events. (Any shift in how the debt is shared after such a recalculation could have tax consequences.)
The new rules will take effect when the IRS reissues them in final form. They will only apply to new debts incurred after such republication.
More significantly, the IRS said it is studying whether the same principle should be extended to other partners “that are capitalized with nominal equity.”