10B — August 29 - September 11, 2014 — Owners, Developers & Managers — M id A tlantic

Real Estate Journal


2014 G overnor ’ s C onference By Robert E. Demmett, CPA, MS, WithumSmith & Brown The bottom dollar guarantee


ne of the major ad- vantages of owning real estate in a part-

nership for tax purposes. The LLC owns real estate with a tax basis of $1 million and a fair market value of $5 million. The LLC borrows $3 million from a bank on a non-recourse basis, that is, the bank can only look to the property for repayment. Neither partner is personally obligated to repay the bank. Immediately after the borrowing, the LLC dis- tributes the $3 million equally to the two partners. As long as the non-recourse liability is allocated equally to the two partners, the with- drawal of $1.5 million by each

partner is a tax free transac- tion. This follows Section 752 of the Internal Revenue Code which states that any increase in a partner’s share of the li- abilities of a partnership shall be considered a contribution of money by such partner to the partnership. In effect, the partner’s outside tax basis is deemed to increase by his share of the increase in the partnership’s liabilities. This increase can provide sufficient tax basis to allow a withdrawal of funds to be considered a tax-free return of basis. Ad- ditionally, such an increase in

outside tax basis can permit the use of valuable deduc- tions, the benefit of which may have been deferred absent the increase in liabilities and tax basis. While an increase in a part- ner’s share of partnership lia- bilities increases the partner’s outside basis, a decrease in the partner’s share of partner- ship liabilities decreases the partner’s outside basis. Thus, it is important for partner A and B that their share of the partnership’s liabilities does not significantly decrease. A significant decrease may have

the same effect as withdraw- ing money in excess of tax ba- sis, i.e. resulting in a current taxable gain. Thus, a partnership that is contemplating taking in new partners or contributing its property to a larger partner- ship (for example, a real estate venture fund) must examine how the reallocation of its li- abilities will affect the tax li- ability of its current partners. A partner who is facing a taxable event due to the reallo- cation of liabilities may find it beneficial to guarantee a por- tion of the partnership’s non- recourse liabilities. A guar- antee will convert a portion of the non-recourse liability to a recourse liability. Partner- ship recourse liabilities are allocated to that partner who may be ultimately liable for the debt. Thus, by guarantee- ing the debt, the partner may be able to maintain a sufficient allocation of partnership li- abilities to avoid gain. While a guarantee of debt is good for tax purposes, most partners are not willing to take on a possible liability that they did not have previously. A guarantee may not be a good economic choice. BOTTOM DOLLAR GUARANTEE: A method of guaranteeing the debt while mitigating the economic risk of satisfying the guarantee is a so-called “bot- tom dollar guarantee.” This is a guarantee where the partner agrees to repay partnership debt only if the bank col- lects less than the guaranteed amount from the partnership. In the example above, if part- ner A signs a bottom dollar guarantee for $1 million, part- ner A will only have to satisfy this guarantee if the bank can- not collect at least $1 million of the $3 million debt from the partnership. Once the bank collects $1 million from the partnership, partner A is relieved of all further liability on the debt. This is contrary to a normal guarantee, where the guarantor is liable for any and all amounts of the debt left unsatisfied by the partnership up to the stated guarantee amount. The Internal Revenue Ser- vice has been struggling with the issue of whether a bot- tom dollar guarantee is a real guarantee and should be respected as such for tax continued on page 16B

nership is the ability to le- verage the real estate and distrib- ute the pro- ceeds of the borrowing to the partners on a tax free basis.

Robert Demmett

FOR EXAMPLE: Individuals A & B equally own a Limited Liability Com- pany that is treated as a part-

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