- It determines if a distribution is taxable
- It determines if there is a gain on selling your partnership interest
- It determines if a partner can deduct “flow-through” losses
For all of the above reasons, partners would generally prefer to have a higher tax basis in their ownership of the partnership. Partner’s will generally get basis for the amount of investment they have at risk in the partnership. They also can get basis for being at risk for partnership liabilities. In some cases, this has led to partners claiming limited, “Bottom dollar guarantees,” in which the partner is only liable for the debt, when the lender fails to recoup a stated minimum repayment from another partner or property. Such guarantees may have no practical economic risk for the guarantor, providing a tax benefit for the partner without actual risk.
Treasury regulations now provide guidance under code section 752 with the intention of ending the use of “bottom dollar guarantees.” Under the new rules, Partners cannot include such guarantees in their partnership tax basis. However, the regulations provided an exception, “90% rule.” Under this rule a partner can still include a bottom dollar guarantee if they are not indemnified for more than 10% of the liability. For example, suppose partner A, guarantees 100% of a partnership liability while partner B, also promise to be liable the first 5%. Partner A has made a 95% bottom dollar guarantee, which can be included in partner A’s tax basis.