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Tax News
The Days of the Bottom-Dollar Guarantee Are Numbered
February 11, 2014
Administrative Actions
It is official. A few weeks ago Treasury released the promised Sec. 707 and 752 proposed regulations (REG-119305-11). While the Regulations propose various material changes that could affect funds and their business, the one that stands out is the obliteration of the “bottom-dollar” guarantee. While the “bottom-dollar” guarantee is most common in the real estate fund industry, it could show up in any type of leveraged partnership deal that attempts to divest an investor on a tax deferred basis. I would imagine that readers are familiar with the disguised sale leveraged distribution rules and the recourse liability allocation rules. For those that are not, the gist is that if a partner guarantees a partnership liability, said partner is treated as having the economic risk of loss and is allocated the portion of that liability up to the guarantee for tax purposes (i.e. the guarantee pulls outside basis). In the past, this rule has presented not one or two opportunities for investors who want to strip cash from a business without recognizing tax currently.  The problem for some of these investors, of course, is that they have to provide a real guarantee to derive the tax benefit. What is a real guarantee has been subject to many discussions and court decisions, but for Sec. 752 purposes, the important part is that until recently, “bottom-dollar” guarantees were treated as “real.”

What is a “bottom-dollar” guarantee? It is a guarantee where the partner agrees to repay partnership debt only after the creditor has exhausted its remedy against the partnership and collected less than X amount of dollars. For example, partnership holds an asset worth $1,000 encumbered by a liability of $500. Partner says that it will guarantee $250 but only if the creditor can’t recover $250 from the partnership. Is this guarantee “real?” Well, it depends on who you ask. If you ask practitioners, it is real. If you ask the IRS, after the impending effective date of the proposed regulations, it is not real. This change has been brewing for a while. The 2010 Canal decision (135 T.C. 199) offered some inkling of this possible change. Then Clifford Warren, special counsel in the IRS Office of Associate Chief Counsel (Passthroughs and Special Industries) came on the record that Treasury will issue proposed regulations addressing “bottom-dollar” guarantees. While practitioners knew that some objective rule was coming that would weed out “bottom-dollar” guarantees with tax abusive element, I think that many were surprised that Treasury took the approach of nixing “bottom-dollar” guarantees altogether.  While the regulations are still in proposed form and thus, nonbinding, taxpayers may want to begin to reassess “bottom-dollar” guarantees as a partnership monetization strategy.
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Tags: "bottom-dollar" guarantee, disguised sales, Section 707, Section 752