United States

IRS rules debt assumption avoids disguised sale treatment

TAX BLOG


In a recent private letter ruling (PLR 201714028) the IRS provided insight into how they view liability assumptions post issuance of the 2016 regulations (see our alert). Based upon the facts and taxpayer representations the IRS ruled that the transferred liabilities were qualified liabilities, despite the fact that some of those liabilities were incurred by the corporate transferor to make distributions.

Based upon the ruling it would appear that as long as liabilities assumed by a partnership in an IRC section 721 transfer were not incurred in anticipation of the assumption, they stand a good chance of representing qualified liabilities.

The PLR involved a corporate transferor who transferred property to a partnership in exchange for partnership units. In connection with the transfer, the partnership assumed liabilities of the corporation, some of which were incurred to make distributions in connection with the formation of the corporation. The transfer of assets and liabilities was structured to qualify for nonrecognition treatment under IRC section 721. The taxpayer requested a ruling from the IRS concerning whether the liabilities transferred and assumed by the partnership, constituted qualified liabilities under Reg. Sec. 1.707-5(a)(6)(i)(E) and thus potentially avoiding disguised sale treatment.

The IRS held that the taxpayer’s liabilities constituted qualified liabilities. As qualified liabilities, the assumption of those liabilities could potentially allow the taxpayer to avoid treatment as disguised sale proceeds. Unfortunately the IRS redacted how long ago the liabilities had been in place, so it is not clear when the liabilities were incurred. However, what is clear based upon the taxpayer representations is that the liabilities were not anticipatory liabilities and the liabilities were an integral part of the taxpayer’s existing and historical capital structure. Specifically, the taxpayer represented that

  1. the liabilities were not incurred in anticipation of the transfer
  2. the transfer was not contemplated when the liabilities were incurred, and
  3. the company would have incurred the liabilities regardless of the transaction.

The PLR seems to provide comfort in the fact that as long as liabilities are not anticipatory and occur regardless of the partnership transaction, nonrecognition tax treatment will be available. The ruling should also serve as a warning to taxpayers, as the IRS has given an indication that anticipatory liabilities by a transferor, such as a corporation borrowing money to fund a distribution to a shareholder, likely won’t represent an ordinary course liability. As a result, borrowing cash and funding a large “extraordinary” distribution prior to a corporation transferring assets and liabilities to a partnership seems likely to bring disguised sale treatment into play.

The partnership disguised sale rules are complex and subject to interpretation. Consult with a tax advisor on the proper tax treatment of liability assumption occurring with property transfers to new or existing partnerships.


Nick Gruidl

Partner

Nick advises businesses on M&A activity, restructuring, partnerships and NOL issues, among other topics. Reach him at nick.gruidl@rsmus.com.

Areas of focus: Corporate TaxationMergers & AcquisitionsPrivate EquityWashington National Tax