However, if the partnership loan is recourse, they may exclude the cancellation of debt income (and not pay tax on this income), to the extent of their respective insolvencies. Partners need to report this income on their tax returns.In other words, if the worst partnership liquidation scenario were to occur, rendering all the partnership assets worthless and all the partnership liabilities fully due and payable – that partner or related person would ultimately be responsible to repay the loan, without receiving any entitlement to reimbursement from another partner or related person.By contrast, IRC Section 752 defines a partnership loan as a liability in which no partner or related person bears the economic risk of loss.The IRC Section 704b regulations present this possibility but the Code section does not define this classification of liability.Case law, however, defines nonrecourse debt as debt in which the creditor’s right of recovery is limited to the collateral, or the particular asset securing the liability.
We will call this the “insolvency exception.” On the other hand, if the partnership loan is nonrecourse, the partners may use this insolvency exception. 201525010 (Release Date June 19, 2015), the IRS posited its views on this matter. The Internal Revenue Code (IRC) is silent on what makes a loan recourse or nonrecourse, except for the purposes of determining a partner’s basis in his or her partnership interest.
Different tax consequences will result, depending on the classification of the loan as recourse or nonrecourse.