The allocation of a partnership’s liabilities can have important tax consequences. A partner’s tax basis in his partnership interest includes his share of the partnership’s liabilities. A partner’s tax basis in his partnership interest is significant because any losses the partner is allocated from the partnership in excess of his basis are suspended, and cash distributions the partner receives from the partnership are generally taxable only to the extent they exceed his basis.

If a partner’s share of partnership liabilities increases, the increase is treated as a contribution of money to the partnership, thereby increasing his tax basis in his partnership interest. Conversely, if a partner’s share of partnership liabilities decreases, the decrease is treated as a distribution of money by the partnership to the partner, which decreases his tax basis (and to the extent the deemed distribution exceeds the partner’s tax basis, it will be taxable to him).