[Federal Register Volume 69, Number 155 (Thursday, August 12, 2004)]
[Proposed Rules]
[Pages 49832-49836]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 04-18372]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[REG-128767-04]
RIN 1545-BD48


Treatment of Disregarded Entities Under Section 752

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking.

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SUMMARY: The proposed regulations provide rules under section 752 for 
taking into account certain obligations of a business entity that is 
disregarded as separate from its owner under sections 856(i), 
1361(b)(3), or Sec. Sec.  301.7701-1 through 301.7701-3 (disregarded 
entity) for purposes of characterizing and allocating partnership 
liabilities. The rules affect partnerships with partnership debt and 
partners in those partnerships. These proposed regulations clarify the 
existing regulations concerning when a partner may be treated as 
bearing the economic risk of loss for a partnership liability based 
upon an obligation of a disregarded entity.

DATES: Written or electronic comments and requests for a public hearing 
must be received by November 10, 2004.

ADDRESSES: Send submissions to: CC:PA:LPD:PR (REG-128767-04), room 
5203, Internal Revenue Service, POB 7604, Ben Franklin Station, 
Washington, DC 20044. Submissions may also be hand delivered Monday 
through Friday between the hours of 8 a.m. and 4 p.m. to: CC:PA:LPD:PR 
(REG-128767-04), Courier's Desk, Internal Revenue Service, 1111 
Constitution Avenue, NW., Washington, DC, or sent electronically, via 
the IRS Internet site at: http://www.irs.gov/regs, or via the Federal 
eRulemaking Portal at: http://www.regulations.gov (IRS-REG-128767-04).

FOR FURTHER INFORMATION CONTACT: Concerning the regulations, Michael J. 
Goldman, (202) 622-3070; concerning submissions of the comments and the 
public hearing, Robin Jones, (202) 622-3521 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

    The collection of information contained in this notice of proposed 
rulemaking has been submitted to the Office of Management and Budget 
for review in accordance with the Paperwork Reduction Act of 1995 (44 
U.S.C. 3507(d)). Comments on the collection of information should be 
sent to the Office of Management and Budget, Attn: Desk Officer for the 
Department of the Treasury, Office of Information and Regulatory 
Affairs, Washington, DC 20503, with copies to the Internal Revenue 
Service, Attn: IRS Reports Clearance Officer, SE:W:CAR:MP:T:T:SP; 
Washington, DC 20224. Comments on the collection of information should 
be received by October 12, 2004. Comments are specifically requested 
concerning:
    Whether the proposed collection of information is necessary for the 
proper performance of the functions of the Internal Revenue Service, 
including whether the information will have practical utility;
    The accuracy of the estimated burden associated with the proposed 
collection of information (see below);
    How the quality, utility, and clarity of the information to be 
collected may be enhanced;
    How the burden of complying with the proposed collection of 
information may be minimized, including through the application of 
automated collection techniques or other forms of information 
technology; and
    Estimates of capital or start-up costs and costs of operation, 
maintenance, and purchase of service to provide information.
    The collection of information in this proposed regulation is in 
Sec.  1.752-2(k). This information is required to ensure proper 
allocations of partnership liabilities. This information will be used 
to determine the extent to which certain partners or related persons 
bear the economic risk of loss with respect to partnership liabilities. 
The collection of information is mandatory. The likely reporters are 
individuals and small businesses or organizations.
    Estimated total annual reporting burden: 500 hours.
    The estimated annual burden per respondent varies from 6 minutes to 
2 hours, depending on individual circumstances, with an estimated 
average of 1 hour.
    Estimated number of respondents: 500.
    Estimated frequency of responses: On occasion.
    An agency may not conduct or sponsor, and a person is not required 
to respond to, a collection of information unless it displays a valid 
control number assigned by the Office of Management and Budget.
    Books or records relating to a collection of information must be 
retained as long as their contents may become material in the 
administration of any internal revenue law. Generally, tax returns and 
tax return information are confidential, as required by 26 U.S.C. 6103.

Background

    Under section 752, a partner's basis in its partnership interest 
includes the partner's share of partnership liabilities. The Income Tax 
Regulations under section 752 provide rules relating to the 
determination of a partner's share of partnership liabilities. Those 
rules differ depending upon whether the liability is characterized as 
recourse or nonrecourse for purposes of section 752. Section 1.752-1(a) 
provides that a partnership liability is a recourse liability to the 
extent that any partner or related person bears the economic risk of 
loss for that liability under Sec.  1.752-2. Section 1.752-1(a) also 
provides that a partnership liability is a nonrecourse liability to the 
extent that no partner or related person bears the economic risk of 
loss for that liability under Sec.  1.752-2.
    In general, a partner bears the economic risk of loss for a 
partnership

[[Page 49833]]

liability under Sec.  1.752-2 to the extent that the partner or a 
related person (as defined in Sec.  1.752-4(b)) has an obligation to 
make a payment to any person, including a contribution to the 
partnership, that is recognized under Sec.  1.752-2(b)(3) on account of 
the partnership liability if the partnership were to constructively 
liquidate as described in Sec.  1.752-2(b) (payment obligation). As 
provided in Sec.  1.752-2(b)(3) and (5), all statutory and contractual 
obligations relating to the partnership liability and reimbursement 
rights are taken into account in determining whether a partner or 
related person has a payment obligation under Sec.  1.752-2(b). 
Moreover, for purposes of determining the extent to which a partner or 
related person has a payment obligation and the economic risk of loss 
for a partnership liability, Sec.  1.752-2(b)(6) provides that it is 
presumed that all partners and related persons who have obligations to 
make payments actually perform those obligations, irrespective of their 
actual net worth (presumption of deemed satisfaction), unless the facts 
and circumstances indicate a plan to circumvent or avoid the 
obligation.
    These proposed regulations clarify the existing regulations 
concerning when a partner may be treated as bearing the economic risk 
of loss for a partnership liability based upon a payment obligation of 
a business entity that is disregarded as separate from its owner under 
sections 856(i), 1361(b)(3), or Sec. Sec.  301.7701-1 through 301.7701-
3 of this chapter (disregarded entity). Because a disregarded entity 
and its owner are treated as a single entity, the presumption of deemed 
satisfaction of obligations undertaken by the owner arguably should 
include payment obligations undertaken by the disregarded entity. 
However, because of statutory limitations on liability, the owner of a 
disregarded entity may have no obligation to satisfy payment 
obligations undertaken by the disregarded entity. The current 
regulations consider such limitations on the payment obligations of a 
partner or related person to be relevant in determining the extent to 
which the partner or related person is treated as bearing the economic 
risk of loss for a partnership liability. The IRS and Treasury 
Department believe that because only the assets of a disregarded entity 
may be available to satisfy payment obligations undertaken by the 
disregarded entity, a partner should be treated as bearing the economic 
risk of loss for a partnership liability as a result of those payment 
obligations only to the extent of the net value of the disregarded 
entity's assets.

Explanation of Provisions

    The proposed regulations provide that in determining the extent to 
which a partner bears the economic risk of loss for a partnership 
liability, payment obligations of a disregarded entity are taken into 
account for purposes of section 752 only to the extent of the net value 
of the disregarded entity as of the date on which the partnership 
determines the partner's share of partnership liabilities pursuant to 
Sec. Sec.  1.752-4(d) and 1.705-1(a). However, the proposed regulations 
do not apply to an obligation of a disregarded entity to the extent 
that the owner of the disregarded entity otherwise is required to make 
a payment (that satisfies the requirements of Sec.  1.752-2(b)(1)) with 
respect to such obligation of the disregarded entity.
    Under the proposed regulations, the net value of a disregarded 
entity equals the fair market value of all assets owned by the 
disregarded entity that may be subject to creditors' claims under local 
law, including the disregarded entity's enforceable rights to 
contributions from its owner but excluding the disregarded entity's 
interest in the partnership (if any) and the fair market value of 
property pledged to secure a partnership liability (which is already 
taken into account under Sec.  1.752-2(h)(1)), less obligations of the 
disregarded entity that do not constitute, and are senior or of equal 
priority to, payment obligations of the disregarded entity. After the 
net value of a disregarded entity is initially determined under the 
rules of the proposed regulations, the net value of the disregarded 
entity is not redetermined unless the obligations of the disregarded 
entity that do not constitute, and are senior or of equal priority to, 
payment obligations of the disregarded entity change by more than a de 
minimis amount or there is more than a de minimis contribution to or 
distribution from the disregarded entity. The IRS and Treasury 
Department request comments on whether other events (such as a sale of 
substantially all of a disregarded entity's assets) should be specified 
as revaluation events and whether a partner should be able to make an 
election to revalue a disregarded entity annually regardless of the 
occurrence of a revaluation event. An election to revalue annually 
would be revocable only with the Commissioner's consent.
    The proposed regulations also provide that the net value of a 
disregarded entity is determined by taking into account a subsequent 
reduction in the net value of the entity if the subsequent reduction is 
anticipated and is part of a plan that has as one of its principal 
purposes creating the appearance that a partner bears the economic risk 
of loss for a partnership liability. In addition, under the proposed 
regulations, if one or more disregarded entities have payment 
obligations with respect to one or more partnership liabilities, or 
liabilities of more than one partnership, the partnership must allocate 
the net value of each disregarded entity among partnership liabilities 
in a reasonable and consistent manner, taking into account priorities 
among partnership liabilities.
    To facilitate the partnership's determination of the net value of a 
disregarded entity, the proposed regulations provide that a partner 
that may be treated as bearing the economic risk of loss for a 
partnership liability based upon a payment obligation of a disregarded 
entity must provide information as to the entity's tax classification 
and net value to the partnership on a timely basis.
    The IRS and Treasury Department are considering and request 
comments regarding whether the rules of the proposed regulations should 
be extended to the payment obligations of other entities, such as 
entities that are capitalized with nominal equity.
    The proposed regulations also include conforming changes to Sec.  
1.704-2(f)(2), (g)(3) and (i)(4). Section 1.704-2 includes rules that 
apply when the character of partnership debt under section 752 changes 
as a result of a guarantee, lapse of a guarantee, conversion, 
refinancing or other change in the debt instrument. Under the proposed 
regulations, those rules would apply upon any change in the character 
of partnership debt under section 752, whether as a result of the 
circumstances specified in the current regulations or as a result of 
changes under the rules of the proposed regulations.
    Finally, the proposed regulations clarify that the pledge rules of 
the regulations under Sec.  1.752-2(h) refer to the net fair market 
value of property pledged to secure a partnership liability. The IRS 
and Treasury Department are considering and request comments regarding 
whether partners should be able to make an election, revocable only 
with the Commissioner's consent, to revalue pledged assets annually.

Proposed Effective Date

    The regulations are proposed to apply to liabilities incurred or 
assumed by a partnership on or after the date the regulations are 
published as final regulations in the Federal Register,

[[Page 49834]]

other than liabilities incurred or assumed by a partnership pursuant to 
a written binding contract in effect prior to that date.

Special Analyses

    It has been determined that this notice of proposed rulemaking is 
not a significant regulatory action as defined in Executive Order 
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. It is hereby 
certified that the collection of information in these regulations will 
not have a significant economic impact on a substantial number of small 
entities. This certification is based on the fact that the amount of 
time necessary to report the required information will be minimal. 
Accordingly, a Regulatory Flexibility Analysis under the Regulatory 
Flexibility Act (5 U.S.C. chapter 6) does not apply. 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 Requests for a Public Hearing

    Before these proposed regulations are adopted as final regulations, 
consideration will be given to any written (a signed original and 8 
copies) or electronic comments that are submitted timely to the IRS. 
The IRS and Treasury Department request comments on the clarity of the 
proposed rules, how they can be made easier to understand and the 
administrability of the rules in the proposed regulations. All comments 
will be available for public inspection and copying. A public hearing 
may be scheduled if requested in writing by any person who timely 
submits written comments. If a public hearing is scheduled, notice of 
the date, time, and place of the public hearing will be published in 
the Federal Register.

Drafting Information

    The principal author of these proposed regulations is Michael J. 
Goldman of the Office of Associate Chief Counsel (Passthroughs and 
Special Industries). Other personnel from the Treasury Department and 
the IRS participated in their development.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

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 continues to read, 
in part, as follows:

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

    Par. 2. Section 1.704-2 is amended as follows:
    1. Paragraph (f)(2) is revised.
    2. The first sentence of paragraph (g)(3) is revised.
    3. The third sentence of paragraph (i)(4) is revised.
    4. Paragraph (l)(1)(iv) is added.
    The revisions and addition read as follows:


Sec.  1.704-2  Allocations attributable to nonrecourse liabilities.

* * * * *
    (f) * * *
    (2) Exception for certain conversions and refinancings. A partner 
is not subject to the minimum gain chargeback requirement to the extent 
the partner's share of the net decrease in partnership minimum gain is 
caused by a recharacterization of nonrecourse partnership debt as 
partially or wholly recourse debt or partner nonrecourse debt, and the 
partner bears the economic risk of loss (within the meaning of Sec.  
1.752-2) for the liability.
* * * * *
    (g) * * *
    (3) Conversions of recourse or partner nonrecourse debt into 
nonrecourse debt. A partner's share of minimum gain is increased to the 
extent provided in this paragraph (g)(3) if a recourse or partner 
nonrecourse liability becomes partially or wholly nonrecourse. * * *
* * * * *
    (i) * * *
    (4) * * * A partner is not subject to this minimum gain chargeback, 
however, to the extent the net decrease in partner nonrecourse debt 
minimum gain arises because a partner nonrecourse liability becomes 
partially or wholly a nonrecourse liability. * * *
* * * * *
    (l) * * * (1) * * *
    (iv) Paragraph (f)(2), the first sentence of paragraph (g)(3), and 
the third sentence of paragraph (i)(4) of this section apply to 
liabilities incurred or assumed by a partnership on or after the date 
the regulations are published as final regulations in the Federal 
Register, other than liabilities incurred or assumed by a partnership 
pursuant to a written binding contract in effect prior to that date. 
Otherwise, the rules applicable to liabilities incurred or assumed (or 
subject to a binding contract in effect) prior to the date the 
regulations are published as final regulations in the Federal Register 
are contained in Sec.  1.704-2 in effect prior to the date the 
regulations are published as final regulations in the Federal Register 
(see 26 CFR part 1 revised as of April 1, 2004).
* * * * *
    Par. 3. Section 1.752-2 is amended as follows:
    1. Paragraph (a) is revised.
    2. The last sentence of paragraph (b)(6) is revised.
    3. Paragraph (h)(3) is revised.
    4. Paragraphs (k) and (l) are added.
    The revisions and additions read as follows:


Sec.  1.752-2  Partner's share of recourse liabilities.

    (a) In general. A partner's share of a recourse partnership 
liability equals the portion of that liability, if any, for which the 
partner or related person bears the economic risk of loss. The 
determination of the extent to which a partner bears the economic risk 
of loss for a partnership liability is made under the rules in 
paragraphs (b) through (k) of this section.
    (b) * * *
    (6) * * * See paragraphs (j) and (k) of this section.
* * * * *
    (h) * * *
    (3) Valuation. The extent to which a partner bears the economic 
risk of loss for a partnership liability as a result of a direct pledge 
described in paragraph (h)(1) of this section or an indirect pledge 
described in paragraph (h)(2) of this section is limited to the net 
fair market value of the property at the time of the pledge or 
contribution. For purposes of this paragraph, if property is subject to 
one or more other obligations that are senior or of equal priority to 
the partnership liability, those obligations must be taken into account 
in determining the net fair market value of pledged property.
* * * * *
    (k) Effect of a disregarded entity--(1) In general. In determining 
the extent to which a partner bears the economic risk of loss for a 
partnership liability, obligations of a business entity that is 
disregarded as an entity separate from its owner under sections 856(i) 
or 1361(b)(3) or Sec. Sec.  301.7701-1 through 301.7701-3 of this 
chapter (disregarded entity), that may be taken into account under 
paragraph (b)(1) of this section, are taken into account only to the 
extent

[[Page 49835]]

of the net value of the disregarded entity (as determined under 
paragraph (k)(2) of this section) as of the date on which the 
partnership determines the partner's share of partnership liabilities 
pursuant to Sec. Sec.  1.752-4(d) and 1.705-1(a) that is allocated to 
the liability under paragraph (k)(4) of this section. The rules of this 
paragraph (k) do not apply to an obligation of a disregarded entity to 
the extent that the owner of the disregarded entity otherwise is 
required to make a payment (that satisfies the requirements of 
paragraph (b)(1) of this section) with respect to such obligation of 
the disregarded entity.
    (2) Net value of a disregarded entity. For purposes of paragraph 
(k)(1) of this section, the net value of a disregarded entity equals 
the fair market value of all assets owned by the entity that may be 
subject to creditors' claims under local law, including the entity's 
enforceable rights to contributions from its owner but excluding the 
entity's interest in the partnership (if any) and the fair market value 
of property pledged to secure a partnership liability under paragraph 
(h)(1) of this section, less obligations of the disregarded entity that 
do not constitute, and are senior or of equal priority to, obligations 
of the disregarded entity that may be taken into account under 
paragraph (b)(1) of this section. After the net value of a disregarded 
entity is initially determined for purposes of paragraph (k)(1) of this 
section, the net value of the disregarded entity is not redetermined 
unless the obligations of the disregarded entity that are described in 
the preceding sentence change by more than a de minimis amount or there 
is more than a de minimis contribution to or distribution from the 
disregarded entity of property other than property pledged to secure a 
partnership liability under paragraph (h)(1) of this section.
    (3) Reduction in net value of a disregarded entity. For purposes of 
paragraph (k)(2) of this section, the net value of a disregarded entity 
is determined by taking into account a subsequent reduction in the net 
value of the disregarded entity if at the time the net value of the 
disregarded entity is determined it is anticipated that the net value 
of the disregarded entity will subsequently be reduced and the 
reduction is part of a plan that has as one of its principal purposes 
creating the appearance that a partner bears the economic risk of loss 
for a partnership liability.
    (4) Allocation of net value. If one or more disregarded entities 
have obligations that may be taken into account under paragraph (b)(1) 
of this section with respect to one or more partnership liabilities, or 
liabilities of more than one partnership, the partnership must allocate 
the net value of each disregarded entity among partnership liabilities 
in a reasonable and consistent manner, taking into account priorities 
among partnership liabilities.
    (5) Information to be provided by the owner of a disregarded 
entity. A partner that may be treated as bearing the economic risk of 
loss for a partnership liability based upon an obligation of a 
disregarded entity that may be taken in account under paragraph (b)(1) 
of this section must provide information as to the entity's tax 
classification and net value to the partnership on a timely basis.
    (6) The following examples illustrate the rules of this paragraph 
(k):

    Example 1. Disregarded entity with net value of zero. (i) In 
2005, A forms a wholly owned domestic limited liability company, 
LLC, with a contribution of $100,000. A has no liability for LLC's 
debts, and LLC has no enforceable right to contribution from A. A 
files no election with respect to LLC under Sec.  301.7701-3 of this 
chapter. Also in 2005, LLC contributes $100,000 to LP, a limited 
partnership with a calendar year taxable year, in exchange for a 
general partnership interest in LP, and B and C each contributes 
$100,000 to LP in exchange for a limited partnership interest in LP. 
The partnership agreement provides that only LLC is required to make 
up any deficit in its capital account. On January 1, 2006, LP 
borrows $300,000 from a bank and uses $600,000 to purchase 
nondepreciable property. The $300,000 debt is secured by the 
property and is also a general obligation of LP. LP makes payments 
of only interest on its $300,000 debt during 2006. Under Sec. Sec.  
1.752-4(d) and 1.705-1(a), LP determines its partners' shares of the 
$300,000 debt at the end of its taxable year, December 31, 2006. As 
of that date, LLC holds no assets other than its interest in LP.
    (ii) Under Sec.  301.7701-3(b)(1)(ii) of this chapter, LLC is a 
disregarded entity. Because LLC is a disregarded entity, A is 
treated as the partner in LP for federal tax purposes. Only LLC has 
an obligation to make a payment on account of the $300,000 debt if 
LP were to constructively liquidate as described in paragraph (b)(1) 
of this section. Therefore, under paragraph (k) of this section, A 
is treated as bearing the economic risk of loss for LP's $300,000 
debt only to the extent of LLC's net value. Because that net value 
is $0 on December 31, 2006, when LP determines its partners' shares 
of its $300,000 debt, A is not treated as bearing the economic risk 
of loss for any portion of LP's $300,000 debt. As a result, LP's 
$300,000 debt is characterized as nonrecourse under Sec.  1.752-1(a) 
and is allocated as required by Sec.  1.752-3.
    Example 2. Disregarded entity with positive net value. (i) The 
facts are the same as in Example 1 except that on January 1, 2007, A 
contributes $250,000 to LLC and LLC shortly thereafter uses the 
$250,000 to purchase unimproved land. LP makes payments of only 
interest on its $300,000 debt during 2007. Under Sec. Sec.  1.752-
4(d) and 1.705-1(a), LP again determines its partners' shares of the 
$300,000 debt at the end of its taxable year, December 31, 2007. As 
of that date, LLC holds its interest in LP and the land, the value 
of which has declined to $175,000.
    (ii) A's contribution of $250,000 to LLC on January 1, 2007, 
constitutes a more than de minimis contribution of property to LLC. 
Accordingly, under paragraph (k)(2) of this section, LLC's value is 
redetermined on December 31, 2007, when LP determines its partners' 
shares of its $300,000 debt. As of that date, LLC's net value is 
$175,000. Therefore, under paragraph (k) of this section, A is 
treated as bearing the economic risk of loss for $175,000 of LP's 
$300,000 debt. As a result, $175,000 of LP's $300,000 debt is 
recharacterized as recourse under Sec.  1.752-1(a) and is allocated 
to A under this section, and the remaining $125,000 of LP's $300,000 
debt remains characterized as nonrecourse under Sec.  1.752-1(a) and 
is allocated as required by Sec.  1.752-3.
    Example 3. Allocation of net value among partnership 
liabilities. (i) The facts are the same as in Example 2 except that 
on January 1, 2008, A forms another wholly owned domestic limited 
liability company, LLC2, with a contribution of $120,000. Shortly 
thereafter, LLC2 uses the $120,000 to purchase stock in X 
corporation. A has no liability for LLC2's debts, and LLC2 has no 
enforceable right to contribution from A. A files no election with 
respect to LLC2 under Sec.  301.7701-3 of this chapter. On July 1, 
2008, LP borrows $100,000 from a bank and uses the $100,000 to 
purchase nondepreciable property. The $100,000 debt is secured by 
the property and is also a general obligation of LP. The $100,000 
debt is senior in priority to LP's existing $300,000 debt. Also on 
July 1, 2008, LLC2 agrees to guarantee both LP's $100,000 and 
$300,000 debts. LP makes payments of only interest on both its 
$100,000 and $300,000 debts during 2008. Under Sec. Sec.  1.752-4(d) 
and 1.705-1(a), LP determines its partners' shares of its $100,000 
and $300,000 debts at the end of its taxable year, December 31, 
2008. As of that date, LLC holds its interest in LP and the land, 
and LLC2 holds the X corporation stock which has appreciated in 
value to $140,000.
    (ii) Under Sec.  301.7701-3(b)(1)(ii) of this chapter, LLC2 is a 
disregarded entity. Both LLC and LLC2 have obligations to make a 
payment on account of LP's debts if LP were to constructively 
liquidate as described in paragraph (b)(1) of this section. 
Therefore, under paragraph (k) of this section, A is treated as 
bearing the economic risk of loss for LP's $100,000 and $300,000 
debts only to the extent of the net values of LLC and LLC2, as 
allocated among those debts in a reasonable manner pursuant to 
paragraph (k)(4) of this section.
    (iii) No events have occurred that would allow a revaluation 
under paragraph (k)(2) of this section. Therefore, LLC's net value 
remains $175,000. LLC2's net value on December 31, 2008, when LP 
determines its partners' shares of its liabilities, is $140,000. 
Under paragraph (k)(4) of this section, LP must allocate the net 
values of LLC and LLC2 between its $100,000 and $300,000 debts in

[[Page 49836]]

a reasonable and consistent manner. Because the $100,000 debt is 
senior in priority to the $300,000 debt, LP first allocates the net 
values of LLC and LLC2, pro rata, to its $100,000 debt. Thus, LP 
allocates $56,000 of LLC's net value and $44,000 of LLC2's net value 
to its $100,000 debt, and A is treated as bearing the economic risk 
of loss for all of LP's $100,000 debt. As a result, all of LP's 
$100,000 debt is characterized as recourse under Sec.  1.752-1(a) 
and is allocated to A under this section. LP then allocates the 
remaining $119,000 of LLC's net value and LLC2's $96,000 net value 
to its $300,000 debt, and A is treated as bearing the economic risk 
of loss for a total of $215,000 of the $300,000 debt. As a result, 
$215,000 of LP's $300,000 debt is characterized as recourse under 
Sec.  1.752-1(a) and is allocated to A under this section, and the 
remaining $85,000 of LP's $300,000 debt is characterized as 
nonrecourse under Sec.  1.752-1(a) and is allocated as required by 
Sec.  1.752-3. This example illustrates one reasonable method for 
allocating net values of disregarded entities among multiple 
partnership liabilities.

    (l) Effective dates. Paragraphs (a), (b)(6), (h)(3), and (k) of 
this section apply to liabilities incurred or assumed by a partnership 
on or after the date the regulations are published as final regulations 
in the Federal Register, other than liabilities incurred or assumed by 
a partnership pursuant to a written binding contract in effect prior to 
that date. Otherwise, the rules applicable to liabilities incurred or 
assumed (or subject to a binding contract in effect) prior to the date 
the regulations are published as final regulations in the Federal 
Register are contained in Sec. Sec.  1.752-2 and 1.752-3 in effect 
prior to the date the regulations are published as final regulations in 
the Federal Register, (see 26 CFR part 1 revised as of April 1, 2004).

    Approved: July 12, 2004.
Nancy Jardini,
Acting Deputy Commissioner for Services and Enforcement.
[FR Doc. 04-18372 Filed 8-11-04; 8:45 am]
BILLING CODE 4830-01-P