Partnership Recourse Loan and At Risk

3 individuals (A, B and C) own two "holding" LLCs, which then own two "operating" LLCs

A owns 80% and B and C each own 10% of 2 LLCs (HoldingA, LLC and HoldingB, LLC)
(but due to certain thresholds that need to be met before B and C receive any allocation of profits and distributions, A currently owns 100% of the capital and any profit/loss allocation)

HoldingA, LLC and HoldingB, LLC each own 50% of two operating LLCs (OperA, LLC and OperB, LLC)
OperA was the original very profitable LLC with positive capital accounts, etc.
OperA was funded completely by Individual A when the company was started.

To help OperB get started, OperA advanced monies during the year.

So we end up with OperA profitable and OperB reporting a loss, basically funded with money loaned from OperA.

Is this a recourse loan on OperB since the lender is affiliated/related to the two LLCs that own OperB?
And will this create basis for the Holding LLCs to deduct the loss?

There is no question that individual A bears the economic risk of loss if OperB fails and can't repay OperA.
But we want to make sure the middle layer with the holding companies doesn't affect that.

Obviously we would like to combine the income and loss together through the two Holding LLCs and ultimately to the individuals.

If they need to put anything into the operating agreement to ensure the above, they will.

I responded to your original question on the previous thread, but now see that you have started another.

We have a loan from one partnership to the other and both partnerships are effectively owned by the same individuals in the same percentages. We’d think it’s a clear-cut case of recourse debt, right?

But if we look at the below example, it seems we get to that recourse result, but only because an entity (AB) was formed to avoid related party status.

Example 5 of the Proposed Regs:

Example (5). Entity structured to avoid related person status. A, B, and C form a general partnership, ABC. A, B, and C are equal partners, each contributing $1,000 to the partnership. A and B want to loan money to ABC and have the loan treated as nonrecourse for purposes of section 752. A and B form partnership AB to which each contributes $50,000. A and B share losses equally in partnership AB. Partnership AB loans partnership ABC $100,000 on a nonrecourse basis secured by the property ABC buys with the loan. Under these facts and circumstances, A and B bear the economic risk of loss with respect to the partnership liability equally based on their percentage interest in losses of partnership AB.

I do understand that there might be a motive to have a debt treated as non-recourse. That stems from the fact that it can then be allocated to ALL of the partners. That is favorable for their basis situation in terms of being able to take distributions against it tax-free. But in your case, such motive doesn’t exist. You want the debt to be recourse so that the losses can be taken against it under the at-risk rules.

I don’t think the intercompany loan would be viewed as a loan coming from the Holdco’s (or the individual partners), so as to invoke 1.752-2(c)(1). The fact is, the loan came from the other operating partnership. But that Reg also says that if the loan doesn’t come directly from a partner, but comes from a party related to the partner, then the partner will be deemed to bear the risk of loss. This means we’d have to get into the related party rule. That involves an 80% requirement. And what we’d be looking at here, I think, is the relationship of the partners (in the borrowing entity) to the lending entity.

With that said, if you end up in a bad position here, would personal guarantees work? And going forward, would it create any problems to distribute out of profitable co (to the partners) and then contribute that cash (by the partners) to loser co?

While those things might solve the problem, I’m still interested in getting a good analysis on this situation absent those things, because I find the whole thing to be confusing. It just seems so obvious that A bears the risk of loss to the tune of 80%, B 10% and C 10%. But a small part of me says that it might make sense that we don’t have a recourse debt here because the lending partnership should be viewed as a separate entity and the lent funds weren’t distributed out of the lending entity (which would have reduced the outside basis of lending partnership’s partners).

Thank you. I didn't see the response in the original thread and thought my question might have gotten lost.
I appreciate your time.
You are right, we are not trying to avoid related party status and would want the loan to be recourse (only for individual A since he bears the economic risk and it was all his money)

Here is some more information that might help.
The 80/10/10 allocation only occurs after the operating partnerships have obtained a certain level of profit. So right now, the 10% owners have contributed no money nor have they been allocated any income or loss nor have they taken any distributions. Individual A currently owns 100% of the capital of both Holding companies and has been allocated 100% of the income from A and the loss from B via the holding companies since day 1. The K-1s for the two 10% members are blank. No income or loss and no capital account activity.

They are new clients and I want to make sure we button this up.
It makes total economic sense to me that Individual A ultimately gets to net the profit from A and loss from B on his individual return via the holding companies. But I want to make sure the IRS would see it the same way.

§ 1.752-2 Partner's share of recourse liabilities.

(a)In general. A partner's share of a recourse partnership liability equals the portion of that liability, if any, for which the partner or related person bears the economic risk of loss.


Since the two Holding LLCs own both the loss LLC and the profit LLC, would they not have economic risk via the profitable LLC if the loss LLC was unable to pay back the loan? I'm trying to narrow down my research. Would the profitable LLC be considered a related person, because they certainly have economic risk. Sometimes it seems straight forward and then I keep reading and it gets muddy.
And the individual A is certainly a related party to the Holding LLCs and he would also have economic risk since it was all his money at the start.

In your case, you basically have single-member LLC’s across the board…you’re just filing 1065’s. For that reason, I don’t think you have any issues in classifying this debt, on OperB’s tax return, as recourse.

And I hear you about this being muddy, hence my comment:

I’m still interested in getting a good analysis on this situation absent those things, because I find the whole thing to be confusing.

If we go back to what we thought was the original scenario [which you posted in the other thread] – two “true” partnerships with identical 80/10/10 partners in each partnership – how would that play out? (And note, this will be your situation when these partnership eventually have more than one partner). In that case, we have one partnership lending to the other partnership. These are related partnerships under 707(b)(1)(B) even when we substitute 50% therein for 80% [related partnerships because the same persons indirectly own 100% of each partnership]. But does that matter? I don’t think it does. I don’t think that’s the relationship we test.

(a)In general. A partner's share of a recourse partnership liability equals the portion of that liability, if any, for which the partner or related person bears the economic risk of loss.

That is just part of the Regulation. There are a few ways an EROL (economic risk of loss) is created. One involves a payment obligation (DRO). Another would be a guarantee, although that’s kind of like a payment obligation. Neither are applicable in your case as things presently stand. But, based on how things presently stand, I think the way we might have an EROL in your situation would be with 1.752-2(c). But that talks about a loan by a partner. The loan in your case wasn’t directly made by a partner of OperB to OperB. It was made by another partnership – OperA - to OperB. Therefore, OperA directly bears the risk of the loss, because OperA holds the receivable. If the loan goes bad, OperA doesn’t get repaid. It theoretically charges off the receivable and takes a bad debt deduction, which passes up to the Holdco’s. That is, the risk of loss gets borne by 50% by HoldingA and 50% by HoldingB. And from there, it gets 100% borne by A, B and C, collectively. So, it sure does seem that we’d classify this debt as recourse and move it up the chain. But when you research the issue, it is far from clear that this is the result. It sure seems like we need to test relatedness between the (1) partners of the borrowing entity [OperB] and (2) the lending entity [OperA]. Again, this all assumes we’re dealing with regarding entities here, but we’re not in your case, since C owns 100% of everything.

I go back that Example #5 in the Proposed Reg (which was the same example in the old regs, they just moved it to a new place). In that example, if A and B made their loans directly to ABC, they’d be recourse, with A’s loan being allocated to A and B’s loan being allocated to B. So they get crafty and form AB partnership, and then run the loan between AB and ABC. The relatedness they test there, for A’s loan, I believe, is: relationship of A to AB. A doesn’t own 80% of AB, so A and AB are not “related.” Ditto for B and AB. So the two loans would be non-recourse. But since the loans were structured to avoid related party status, the Example concludes that A’s loan is recourse and so is B’s.

Example #5 concluded that the loans are recourse. That would be perfectly fine in my situation. And thanks again for your time and help.

That would be perfectly fine in my situation.

Your situation doesn’t even involve partnerships. And Example #5 gets to that conclusion only because of the facts and circumstances contained therein, one of which was that A and B wanted their loans to be treated as non-recourse, so they formed AB partnership.