IRS revised position: Nonrecourse carveouts, debt allocation under section 752

IRS Chief Counsel legal advice memorandum

The IRS publicly released a legal advice memorandum* relating to certain “bad boy” nonrecourse carveouts and their impact on debt allocations under section 752 and at-risk basis under section 465. AM2016-001 (release date April 15, 2016, and dated March 31, 2016)

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Read text of the legal advice memo [PDF 67 KB]


*The memorandum is legal advice, signed by executives in the National Office of the Office of Chief Counsel and issued to IRS personnel who are national program executives and managers. The memo is issued to assist IRS personnel in administering their programs by providing authoritative legal opinions on certain matters, such as industry-wide issues. It is not to be used or cited as precedent..  


Earlier this year, in ILM 201606027, the IRS concluded that certain “bad boy” acts that, upon occurrence would create personal liability for guarantors, would cause partnership debt subject to the carveouts to be treated as recourse under section 752 with respect to the guarantor, and that the debt would no longer qualify as qualified nonrecourse financing for purposes of section 465.  Of particular concern to the IRS was a carveout provision that would be invoked if the borrower “admits in writing or in any legal proceeding that it is insolvent or unable to pay its debts as the come due.”

In AM 2016-001, the IRS has reversed course and concluded that the carveout provisions addressed in ILM 201606027 will not cause the debt to be treated as recourse under section 752 until such provisions are actually invoked.  The IRS reached the same conclusion under section 465, such that these carveouts will not prevent debt from being treated as qualified nonrecourse financing until invoked.

In justifying its conclusion with respect to the “admission of insolvency” carveout, the IRS in the legal advice memorandum stated:


[T]he fundamental business purpose behind such carve-outs and the intent of the parties to such agreements is to prevent actions by the borrower or guarantor that could make recovery on the debt, or acquisition of the security underlying the debt upon default, more difficult.  The “nonrecourse carve-out” provisions should be interpreted consistent with that purpose and intent in mind.  Consequently, because it is not in the economic interest of the borrower or the guarantor to commit the bad acts described in the typical “nonrecourse carve-out” provisions, it is unlikely that the contingency (the bad act) will occur and the contingent payment obligation should be disregarded under § 1.752-2(b)(4).  Therefore, unless the facts and circumstances indicate otherwise, a typical “nonrecourse carve-out” provision that allows the borrower or the guarantor to avoid committing the enumerated bad act will not cause an otherwise nonrecourse liability to be treated as recourse for purposes of section 752 and § 1.752-2(a) until such time as the contingency actually occurs.   

KPMG observation

The ILM released earlier this year gave rise to concerns for a number of entities that now may find good news with the reversal of IRS prior position with the release of AM 2016-001.

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