| ||Does Regulation Section 1.704-2 Permit Special Allocations of Nonrecourse Deductions Attributable to Exculpatory Liabilities? |
Bethany Atkins Rice*
*University of Florida, B.S., 1993; Brandeis School of Law, University of Louisville, J.D., 1998; University of Miami School of Law, LL.M, 2001. The author acknowledges the assistance of Elliott Manning, Professor of Law, University of Miami School of Law, for valuable comments on an earlier draft. Special thanks to Tom Blackburn, Professor of Law, Brandeis School of Law, University of Louisville, and George Mundstock, Professor of Law, University of Minnesota School of Law, for their inspiration.
The section 704(b) regulations of the Internal Revenue Code that allocate nonrecourse deductions for partnerships were originally drafted in tandem with the section 752 regulations, which allocate nonrecourse debt for basis purposes. Combined, these regulations permit special allocations of nonrecourse deductions and ensure that partners in partnerships have sufficient bases to make use of these deductions.
In December 1991, the preamble to then new Regulation section 1.704-2 requested suggestions regarding the appropriate treatment of allocations attributable to exculpatory liabilities that reasonably reflected the principles of section 704(b). In October 2000, the Treasury revised Regulation section 1.752-3 to include guidance regarding allocation of a single liability among multiple properties with built-in gain (section 704(c) property) and encumbered by debt, which were contributed to a partnership.
Part II of this paper provides a description of the regulations that govern special allocations attributable to exculpatory liabilities. Part III concludes that neither Regulation section 1.704-2 nor revised Regulation section 1.752-3 provides enough guidance regarding exculpatory liabilities. Specifically, under current law, exculpatory liabilities not allocated to specific properties do not justify special allocations of nonrecourse deductions.
However, Part IV concludes that special allocations of nonrecourse deductions attributable to exculpatory liabilities are justified based on well-settled tax policy. This is consistent with the liberal approach the Treasury takes regarding all other special allocations of nonrecourse deductions where partnership minimum gain can be calculated, and partners who enjoy deductions must eventually account for those losses.
Finally, Part V proposes that amendments to Regulation sections 1.704-2 and 1.752-2, including incorporating the doctrine of cancellation of indebtedness into the calculation of partnership minimum gain, will justify special allocations of nonrecourse deductions attributable to exculpatory liabilities used to purchase new properties.