In February 2016, the IRS released an internal memorandum concluding that typical 'bad boy guaranties' provided by a partner for partnership debt should be treated as a recourse liability of the guarantor for purposes of allocating the debt, and associated deductions, among the partners. That result could reduce the amount of depreciation deductions that would be allocable to the non-guarantor partners. The memorandum was severely criticized in the tax community, as its conclusion was inconsistent with the way in which most practitioners have treated such guaranties. See Tax Alert for a summary of the memorandum and its implications. The IRS reversed course and concluded in a subsequent memorandum released April 15 that such guaranties should not prevent debt from being characterized as nonrecourse debt (both for purposes of the partnership allocation rules and the at-risk rules).

The IRS concluded as follows:

[B]ecause 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.

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