One might think that a contributor of property to a partnership would not need to worry about having gain from a “disguised sale” of property to the partnership as long as the contributor does not receive any cash. However, a transaction as simple as a contribution of property to a partnership subject to a mortgage may be treated as involving a taxable sale of property to the partnership if the debt is not a “qualified” liability.

While the new Treasury Regulations regarding partnership disguised sales that were issued in October 2016 were generally unfavorable for taxpayers, a taxpayer-friendly provision that was included is a new category of debt that constitutes a qualified liability. In a welcome development, the IRS recently issued a private letter ruling that interpreted the new category of qualified liability in a favorable manner.

Background

A contribution of property to a partnership is generally tax-free, and a distribution of cash from a partnership to a partner is generally tax-free to the extent of the partner's basis in its partnership interest. However, if a partner contributes property to a partnership and the partnership distributes money to the partner within a two-year period, the Treasury Regulations presume there to be a sale of property by the partner to the partnership (a “disguised sale”).

The regulations provide that where a partner contributes property to a partnership and the partnership assumes or takes subject to a liability, the tax consequences depend on whether or not the liability is a “qualified” liability. If the liability is a qualified liability, then the transaction is generally tax-free. Alternatively, if the liability is not a qualified liability, then the partnership is generally treated as transferring cash to the partner to the extent of the decrease in the partner's “share” of the nonqualified liability (as specifically defined for purposes of the disguised sale rules).