Typically, nonrecourse loans are not considered at risk for purposes of the IRC §465 at-risk limitations. An exception to the rule does exist though. When qualified nonrecourse financing is secured by real property used in the activity of holding real property, it can be considered at-risk. Personal property or services incidental to making real property available as living accommodations are treated as part of the activity of holding real property.

This exception recognizes the fact that third-party commercial lenders are less likely to make loans exceeding the property’s value or loans that may not be able to be serviced by the property. Further, it is more probable that financing secured from independent third-party lenders will be repaid as agreed, and that the purchaser’s position in the property will represent real equity instead of a questionable amount created by an inflated valuation to obtain tax deductions.

Qualified nonrecourse financing usually includes financing for which no one is personally liable for repayment that is borrowed for use in an activity of holding real property and that is loaned or guaranteed by a federal, state or local government or that is borrowed from a “qualified” person. Qualified persons are any persons actively and regularly engaged in the business of lending money, such as a bank or commercial lender. While the Section 752 rules provide that a partner’s share of partnership nonrecourse debt adds to that partner’s basis in the partnership interest, a partner’s share of nonrecourse debt generally does not generate basis for purposes of the Section 465 at-risk rules. With this exception, a partner’s share of partnership debt that meets the definition of qualified nonrecourse financing does generate at-risk basis for the partner. To qualify for the exception, a partnership itself may be liable for repayment of the debt, without disqualifying the debt as qualified nonrecourse financing, if the partnership is the only party liable, each partnership with personal liability holds only real property, and the lender just has the right to proceed against the real property if a default occurs.

If you would like to evaluate your basis in a partnership with nonrecourse debt, please feel free to contact us.