[Federal Register Volume 62, Number 156 (Wednesday, August 13, 1997)]
[Proposed Rules]
[Pages 43295-43297]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-21418]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[REG-105160-97]
RIN 1545-AV17


Qualified Nonrecourse Financing Under Section 465(b)(6)

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking and notice of public hearing.

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SUMMARY: This document contains proposed regulations under section 
465(b)(6) regarding qualified nonrecourse financing. The proposed 
regulations address whether the personal liability of an entity 
prevents financing from being treated as qualified nonrecourse 
financing and whether qualified nonrecourse financing may be secured by 
property that is incidental to the activity of holding real property. 
The proposed regulations would affect partnerships and their partners. 
This document also gives notice of a public hearing scheduled for 
December 10, 1997.

DATES: Written comments and requests to speak (with outlines of oral 
comments) at the public hearing scheduled for December 10, 1997, must 
be received by November 19, 1997.

ADDRESSES: Send submissions to: CC:DOM:CORP:R (REG-105160-97), room 
5228, Internal Revenue Service, POB 7604, Ben Franklin Station, 
Washington, DC 20044. In the alternative, submissions may be hand 
delivered between the hours of 8 a.m. and 5 p.m. to: CC:DOM:CORP:R 
(REG-105160-97), Courier's Desk, Internal Revenue Service, 1111 
Constitution Avenue NW., Washington, DC.
    Alternatively, taxpayers may submit comments electronically via the 
Internet by selecting the ``Tax Regs'' option of the IRS Home Page, or 
by submitting comments directly to the IRS Internet site at: http://
www.irs.ustreas.gov/prod/tax__regs/comments.html. The public hearing 
will be held in room 2615, Internal Revenue Building, 1111 Constitution 
Avenue, NW., Washington, DC.

FOR FURTHER INFORMATION CONTACT: Concerning the regulations, Jeffrey A. 
Erickson, (202) 622-3070; concerning submissions and the hearing, 
Michael Slaughter, (202) 622-7190 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Introduction

    This document contains proposed regulations under section 465(b)(6) 
of the Internal Revenue Code (Code). Section 465, which applies to 
individuals and certain corporations, limits a taxpayer's loss 
deduction for an activity to the amount of the taxpayer's amount at 
risk in the activity at the close of the taxable year. A taxpayer's 
amount at risk generally includes the

[[Page 43296]]

amount of any cash and the adjusted tax basis of any property 
contributed by the taxpayer to the activity plus any amounts borrowed 
for use in the activity to the extent the taxpayer is personally liable 
for repayment.
    For the activity of holding real property, a taxpayer may also 
include as an amount at risk the taxpayer's share of any ``qualified 
nonrecourse financing'' that is secured by real property used in the 
activity of holding real property, even though the taxpayer is not 
personally liable for repayment of the financing. Section 465(b)(6) 
defines qualified nonrecourse financing as any financing that (i) is 
borrowed by the taxpayer for the activity of holding real property; 
(ii) is borrowed by the taxpayer from a qualified person or represents 
a loan from any federal, state, or local government or instrumentality 
thereof, or is guaranteed by any federal, state, or local government; 
(iii) except to the extent provided in regulations, no person is 
personally liable for repayment; and (iv) is not convertible debt.

Explanation of Provisions

I. Secured by Real Property

    Section 465(b)(6)(A) provides that qualified nonrecourse financing 
must be secured by real property used in the activity of holding real 
property. The legislative history of section 465(b)(6) suggests that 
qualified nonrecourse financing can be secured only by real property. 
H.R. Rep. No. 426, 99th Cong., 1st Sess. 293 (1985), 1986-3 (Vol. 2) 
C.B. 293; S. Rep. No. 313, 99th Cong., 2d Sess. 748 (1986), 1986-3 
(Vol. 3) C.B. 748. Section 465(b)(6)(E), however, provides that the 
activity of holding real property includes the holding of personal 
property that is incidental to making real property available as living 
accommodations. Section 465(b)(6) does not specifically provide that 
such incidental property may be used to secure qualified nonrecourse 
financing. The proposed regulations provide that financing can qualify 
as qualified nonrecourse financing if, in addition to the real property 
used in the activity of holding real property, the financing is secured 
by both real property and other property that is incidental to the 
activity of holding real property.

II. Personal Liability

    Section 465(b)(6)(B)(iii) provides that, except to the extent 
provided in regulations, no person may be personally liable for 
repayment of qualified nonrecourse financing. The legislative history 
of section 465 states that regulations may provide rules under which 
the guaranty, indemnity, or personal liability of a person other than 
the taxpayer does not cause the financing to be treated as other than 
qualified nonrecourse financing. H.R. Rep. No. 426, 99th Cong., 1st 
Sess. 294 (1985), 1986-3 (Vol. 2) C.B. 294; S. Rep. No. 313, 99th 
Cong., 2d Sess. 749 (1986), 1986-3 (Vol. 3) C.B. 749.
    A partnership is treated as a person under the Code. Thus, any 
financing for which a partnership is personally liable is not qualified 
nonrecourse financing under section 465(b)(6)(B)(iii), even if no 
partner is personally liable for the financing. This result is 
inappropriate if the only activity of the partnership is the real 
property activity; the personal liability of the partnership in that 
situation is not meaningful and the financing is the equivalent of 
nonrecourse financing. Situations in which a partnership is liable for 
repayment, but no partner is personally liable, may be unusual for 
general and limited partnerships; however, such situations may become 
increasingly common with the use of limited liability companies (LLCs) 
in which the LLC is personally liable for its debts and the members of 
the LLC are not liable. In response, the proposed regulations provide 
that the personal liability of a partnership (including an LLC that is 
treated as a partnership) is disregarded in determining whether a 
financing is qualified nonrecourse financing if the entity's only 
assets are real property used in the activity of holding real property 
or both real property and other property that is incidental to the 
activity of holding real property, and no other person is liable for 
the financing.
    In addition, section 465(b)(6) does not specifically provide that 
financing may qualify as qualified nonrecourse financing if a person is 
personally liable for a portion of the financing. Treating the portion 
of the financing for which no person is personally liable as qualified 
nonrecourse financing would not be inconsistent with the underlying 
policy of section 465. Therefore, the proposed regulations provide that 
the portion for which no person is personally liable can qualify as 
qualified nonrecourse financing.

Proposed Effective Date

    These regulations are proposed to be effective for financing 
incurred on or after the date final regulations are published in the 
Federal Register.

Special Analyses

    It has been determined that this notice of proposed rulemaking is 
not a significant regulatory action as defined in EO 12866. Therefore, 
a regulatory assessment is not required. It also has been determined 
that section 553(b) of the Administrative Procedure Act (5 U.S.C. 
chapter 5) does not apply to these regulations, and because these 
regulations do not impose on small entities a collection of information 
requirement, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does 
not apply. Therefore, a Regulatory Flexibility Analysis is not 
required. Pursuant to section 7805(f) of the Internal Revenue Code, 
this notice of proposed rulemaking will be submitted to the Chief 
Counsel for Advocacy of the Small Business Administration for comment 
on its impact on small business.

Comments and Public Hearing

    Before these proposed regulations are adopted as final regulations, 
consideration will be given to any written comments (preferably a 
signed original and eight (8) copies) that are submitted timely to the 
IRS. All comments will be available for public inspection and copying.
    A public hearing has been scheduled for December 10, 1997, at 10 
a.m., in room 2615, Internal Revenue Building, 1111 Constitution Avenue 
NW., Washington, DC. Because of access restrictions, visitors will not 
be admitted beyond the Internal Revenue Building lobby more than 15 
minutes before the hearing starts.
    The rules of 26 CFR 601.601(a)(3) apply to the hearing.
    Persons that wish to present oral comments at the hearing must 
submit timely written comments (preferably a signed original and eight 
(8) copies) and an outline of the topics to be discussed and the time 
to be devoted to each topic by November 19, 1997.
    A period of 10 minutes will be allotted to each person for making 
comments.
    An agenda showing the scheduling of the speakers will be prepared 
after the deadline for receiving outlines has passed. Copies of the 
agenda will be available free of charge at the hearing.

Drafting Information

    The principal author of these regulations is Jeffrey A. Erickson, 
Office of Chief Counsel (Passthroughs and Special Industries). However, 
other personnel from the IRS and Treasury Department participated in 
their development.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

[[Page 43297]]

Proposed Amendments to the Regulations

    Accordingly, 26 CFR Part 1 is proposed to be amended as follows:

PART 1--INCOME TAXES

    Paragraph 1. The authority citation for part 1 is amended by adding 
an entry in numerical order to read as follows:

    Authority: 26 U.S.C. 7805 * * *

    Sec. 1.465-27(b)(3) also issued under 26 U.S.C. 465(b)(6)(B)(iii). 
* * *
    Par. 2. Section 1.465-27 is added to read as follows:


Sec. 1.465-27  Qualified nonrecourse financing.

    (a) In general. Notwithstanding any provision of section 465(b) or 
the regulations under section 465, in the case of an activity of 
holding real property, a taxpayer is considered at risk with respect to 
the taxpayer's share of any qualified nonrecourse financing that is 
secured by real property used in such activity.
    (b) Qualified nonrecourse financing--(1) In general. For section 
465(b)(6) and this section, the term qualified nonrecourse financing 
means any financing--
    (i) Which is borrowed by the taxpayer with respect to the activity 
of holding real property;
    (ii) Which is borrowed by the taxpayer from a qualified person or 
represents a loan from any federal, state, or local government or 
instrumentality thereof, or is guaranteed by any federal, state, or 
local government;
    (iii) Except as otherwise provided in paragraph (b)(3)(ii) of this 
section, for which no person is personally liable for repayment; and
    (iv) Which is not convertible debt.
    (2) Secured by incidental property. A taxpayer will be considered 
at risk with respect to the taxpayer's share of any qualified 
nonrecourse financing secured by real property used in the activity of 
holding real property, where such financing is also secured by property 
that is incidental to the activity of holding such real property.
    (3) Personal liability--(i) Partial liability. If a person is 
personally liable for repayment of a portion of a financing, the 
portion of the financing for which no person is personally liable can 
qualify as qualified nonrecourse financing.
    (ii) Partnership liability. The personal liability of an entity 
classified as a partnership for repayment of a financing shall be 
disregarded in determining whether the financing is qualified 
nonrecourse financing, if the only assets of the partnership are either 
real property used in the activity of holding real property or both 
such real property and other property that is incidental to the 
activity of holding such real property, and no other person is liable 
for repayment of the financing.
    (4) Examples. The following examples illustrate the rules of 
paragraph (b) of this section:

    Example 1. Personal liability of partnership; Incidental 
property. X is a limited liability company that is classified as a 
partnership for federal tax purposes. X is engaged only in the 
activity of holding real property. In addition to real property used 
in the activity of holding real property, X owns office equipment, a 
truck, and maintenance equipment that it uses to support the 
activity of holding real property. X borrows $500 to use in the 
activity. X is personally liable on the financing, but no member of 
X and no other person is liable for repayment of the financing. 
Under paragraph (b)(3)(ii) of this section, the personal liability 
of X for repayment of the financing is disregarded when determining 
whether the financing is qualified nonrecourse financing. Under 
paragraph (b)(2) of this section, the personal property is treated 
as incidental personal property used in the activity of holding real 
property. Therefore, assuming the financing satisfies the other 
requirements for qualified nonrecourse financing, the financing will 
be treated as qualified nonrecourse financing.
    Example 2. Bifurcation of financing. The facts are the same as 
in Example 1, except that A, a member of X, is personally liable for 
repayment of $100 of the financing. Under paragraph (b)(3)(i) of 
this section, the portion of the financing for which A is not 
personally liable for repayment ($400) can qualify as qualified 
nonrecourse financing.

    (c) Effective date. This section is effective for financing 
incurred on or after the date the final regulations are published in 
the Federal Register.
Michael P. Dolan,
Acting Commissioner of Internal Revenue.
[FR Doc. 97-21418 Filed 8-12-97; 8:45 am]
BILLING CODE 4830-01-U