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

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