---
kind: "range"
citation: "26 C.F.R. §§ 1.707-3–1.707-5"
title: "26"
from: "1.707-3"
to: "1.707-5"
count: 3
url: "https://uscodex.org/cfr/26/1.707-3..1.707-5"
---

# §1.707-3. Disguised sales of property to partnership; general rules.

- (a) **Treatment of transfers as a sale—**
  - (1) **In general.** Except as otherwise provided in this section, if a transfer of property by a partner to a partnership and one or more transfers of money or other consideration by the partnership to that partner are described in [paragraph (b)(1)](#b-1) of this section, the transfers are treated as a sale of property, in whole or in part, to the partnership.
  - (2) **Definition and timing of sale.** For purposes of [§§ 1.707-3 through 1.707-5](/cfr/26/1.707-3..1.707-5.md), the use of the term sale (or any variation of that word) to refer to a transfer of property by a partner to a partnership and a transfer of consideration by a partnership to a partner means a sale or exchange of that property, in whole or in part, to the partnership by the partner acting in a capacity other than as a member of the partnership, rather than a contribution and distribution to which sections [721](/cfr/26/721.md) and [731](/cfr/26/731.md), respectively, apply. A transfer that is treated as a sale under [paragraph (a)(1)](#a-1) this section is treated as a sale for all purposes of the Internal Revenue Code (e.g., sections [453](/cfr/26/453.md), [483](/cfr/26/483.md), [1001](/cfr/26/1001.md), [1012](/cfr/26/1012.md), [1031](/cfr/26/1031.md) and [1274](/cfr/26/1274.md)). The sale is considered to take place on the date that, under general principles of Federal tax law, the partnership is considered the owner of the property. If the transfer of money or other consideration from the partnership to the partner occurs after the transfer of property to the partnership; the partner and the partnership are treated as if, on the date of the sale, the partnership transferred to the partner an obligation to transfer to the partner money or other consideration.
  - (3) **Application of disguised sale rules.** If a person purports to transfer property to a partnership in a capacity as a partner, the rules of this section apply for purposes of determining whether the property was transferred in a disguised sale, even if it is determined after the application of the rules of this section that such person is not a partner. If after the application of the rules of this section to a purported transfer of property to a partnership, it is determined that no partnership exists because the property was actually sold, or it is otherwise determined that the contributed property is not owned by the partnership for tax purposes, the transferor of the property is treated as having sold the property to the person (or persons) that acquired ownership of the property for tax purposes.
  - (4) **Deemed terminations under section 708.** In applying the rules of this section, transfers resulting from a termination of a partnership under [section 708(b)(1)(B)](/cfr/26/708.md?p=b-1-B) are disregarded.
- (b) **Transfers treated as a sale—**
  - (1) **In general.** A transfer of property (excluding money or an obligation to contribute money) by a partner to a partnership and a transfer of money or other consideration (including the assumption of or the taking subject to a liability) by the partnership to the partner constitute a sale of property, in whole or in part, by the partner to the partnership only if based on all the facts and circumstances—
    - (i) The transfer of money or other consideration would not have been made but for the transfer of property; and
    - (ii) In cases in which the transfers are not made simultaneously, the subsequent transfer is not dependent on the entrepreneurial risks of partnership operations.
  - (2) **Facts and circumstances.** The determination of whether a transfer of property by a partner to the partnership and a transfer of money or other consideration by the partnership to the partner constitute a sale, in whole or in part, under [paragraph (b)(1)](#b-1) of this section is made based on all the facts and circumstances in each case. The weight to be given each of the facts and circumstances will depend on the particular case. Generally, the facts and circumstances existing on the date of the earliest of such transfers are the ones considered in determining whether a sale exists under [paragraph (b)(1)](#b-1) of this section. Among the facts and circumstances that may tend to prove the existence of a sale under [paragraph (b)(1)](#b-1) of this section are the following:
    - (i) That the timing and amount of a subsequent transfer are determinable with reasonable certainty at the time of an earlier transfer;
    - (ii) That the transferor has a legally enforceable right to the subsequent transfer;
    - (iii) That the partner's right to receive the transfer of money or other consideration is secured in any manner, taking into account the period during which it is secured;
    - (iv) That any person has made or is legally obligated to make contributions to the partnership in order to permit the partnership to make the transfer of money or other consideration;
    - (v) That any person has loaned or has agreed to loan the partnership the money or other consideration required to enable the partnership to make the transfer, taking into account whether any such lending obligation is subject to contingencies related to the results of partnership operations;
    - (vi) That a partnership has incurred or is obligated to incur debt to acquire the money or other consideration necessary to permit it to make the transfer, taking into account the likelihood that the partnership will be able to incur that debt (considering such factors as whether any person has agreed to guarantee or otherwise assume personal liability for that debt);
    - (vii) That the partnership holds money or other liquid assets, beyond the reasonable needs of the business, that are expected to be available to make the transfer (taking into account the income that will be earned from those assets);
    - (viii) That partnership distributions, allocation or control of partnership operations is designed to effect an exchange of the burdens and benefits of ownership of property;
    - (ix) That the transfer of money or other consideration by the partnership to the partner is disproportionately large in relationship to the partner's general and continuing interest in partnership profits; and
    - (x) That the partner has no obligation to return or repay the money or other consideration to the partnership, or has such an obligation but it is likely to become due at such a distant point in the future that the present value of that obligation is small in relation to the amount of money or other consideration transferred by the partnership to the partner.
- (c) **Transfers made within two years presumed to be a sale—**
  - (1) **In general.** For purposes of this section, if within a two-year period a partner transfers property to a partnership and the partnership transfers money or other consideration to the partner (without regard to the order of the transfers), the transfers are presumed to be a sale of the property to the partnership unless the facts and circumstances clearly establish that the transfers do not constitute a sale.
  - (2) **Disclosure of transfers made within two years.** Disclosure to the Internal Revenue Service in accordance with [§ 1.707-8](/cfr/26/1.707-8.md) is required if—
    - (i) A partner transfers property to a partnership and the partnership transfers money or other consideration to the partner with a two-year period (without regard to the order of the transfers);
    - (ii) The partner treats the transfers other than as a sale for tax purposes; and
    - (iii) The transfer of money or other consideration to the partner is not presumed to be a guaranteed payment for capital under [§ 1.707-4(a)(1)(ii)](/cfr/26/1.707-4.md?p=a-1-ii), is not a reasonable preferred return within the meaning of [§ 1.707-4(a)(3)](/cfr/26/1.707-4.md?p=a-3), and is not an operating cash flow distribution within the meaning of [§ 1.707-4(b)(2)](/cfr/26/1.707-4.md?p=b-2).
- (d) **Transfers made more than two years apart presumed not to be a sale.** For purposes of this section, if a transfer of money or other consideration to a partner by a partnership and the transfer of property to the partnership by that partner are more than two years apart, the transfers are presumed not to be a sale of the property to the partnership unless the facts and circumstances clearly establish that the transfers constitute a sale.
- (e) **Scope.** This section and [§§ 1.707-4 through 1.707-9](/cfr/26/1.707-4..1.707-9.md) apply to contributions and distributions of property described in [section 707(a)(2)(A)](/cfr/26/707.md?p=a-2-A) and transfers described in [section 707(a)(2)(B)](/cfr/26/707.md?p=a-2-B) of the Internal Revenue Code.
- (f) **Examples.** The following examples illustrate the application of this section.

# §1.707-4. Disguised sales of property to partnership; special rules applicable to guaranteed payments, preferred returns, operating cash flow distributions, and reimbursements of preformation expenditures.

- (a) **Guaranteed payments and preferred returns—**
  - (1) **Guaranteed payment not treated as part of a sale—**
    - (i) **In general.** A guaranteed payment for capital made to a partner is not treated as part of a sale of property under [§ 1.707-3(a)](/cfr/26/1.707-3.md?p=a) (relating to treatment of transfers as a sale). A party's characterization of a payment as a guaranteed payment for capital will not control in determining whether a payment is, in fact, a guaranteed payment for capital. The term guaranteed payment for capital means any payment to a partner by a partnership that is determined without regard to partnership income and is for the use of that partner's capital. See [section 707(c)](/cfr/26/707.md?p=c). For this purpose, one or more payments are not made for the use of a partner's capital if the payments are designed to liquidate all or part of the partner's interest in property contributed to the partnership rather than to provide the partner with a return on an investment in the partnership.
    - (ii) **Reasonable guaranteed payments.** Notwithstanding the presumption set forth in [§ 1.707-3(c)](/cfr/26/1.707-3.md?p=c) (relating to transfers made within two years of each other), for purposes of [section 707(a)(2)](/cfr/26/707.md?p=a-2) and the regulations thereunder a transfer of money to a partner that is characterized by the parties as a guaranteed payment for capital, is determined without regard to the income of the partnership and is reasonable (within the meaning of [paragraph (a)(3)](#a-3) of this section) is presumed to be a guaranteed payment for capital unless the facts and circumstances clearly establish that the transfer is not a guaranteed payment for capital and is part of a sale.
    - (iii) **Unreasonable guaranteed payments.** A transfer of money to a partner that is characterized by the parties as a guaranteed payment for capital but that is not reasonable (within the meaning of [paragraph (a)(3)](#a-3) of this section) is presumed not to be a guaranteed payment for capital unless the facts and circumstances clearly establish that the transfer is a guaranteed payment for capital. A transfer that is not a guaranteed payment for capital is subject to the rules of [§ 1.707-3](/cfr/26/1.707-3.md).
  - (2) **Presumption regarding reasonable preferred returns.** Notwithstanding the presumption set forth in [§ 1.707-3(c)](/cfr/26/1.707-3.md?p=c) (relating to transfers made within two years of each other), a transfer of money to a partner that is characterized by the parties as a preferred return and that is reasonable (within the meaning of [paragraph (a)(3)](#a-3) of this section) is presumed not to be part of a sale of property to the partnership unless the facts and circumstances (including the likelihood and expected timing of the subsequent allocation of income or gain to support the preferred return) clearly establish that the transfer is part of a sale. The term preferred return means a preferential distribution of partnership cash flow to a partner with respect to capital contributed to the partnership by the partner that will be matched, to the extent available, by an allocation of income or gain.
  - (3) **Definition of reasonable preferred returns and guaranteed payments—**
    - (i) **In general.** A transfer of money to a partner that is characterized as a preferred return or guaranteed payment for capital is reasonable only to the extent that the transfer is made to the partner pursuant to a written provision of a partnership agreement that provides for payment for the use of capital in a reasonable amount, and only to the extent that the payment is made for the use of capital after the date on which that provision is added to the partnership agreement.
    - (ii) **Reasonable amount.** A transfer of money that is made to a partner during any partnership taxable year and is characterized as a preferred return or guaranteed payment for capital is reasonable in amount if the sum of any preferred return and any guaranteed payment for capital that is payable for that year does not exceed the amount determined by multiplying either the partner's unreturned capital at the beginning of the year or, at the partner's option, the partner's weighted average capital balance for the year (with either amount appropriately adjusted, taking into account the relevant compounding periods, to reflect any unpaid preferred return or guaranteed payment for capital that is payable to the partner) by the safe harbor interest rate for that year. The safe harbor interest rate for a partnership's taxable year equals 150 percent of the highest applicable Federal rate, at the appropriate compounding period or periods, in effect at any time from the time that the right to the preferred return or guaranteed payment for capital is first established pursuant to a binding, written agreement among the partners through the end of the taxable year. A partner's unreturned capital equals the excess of the aggregate amount of money and the fair market value of other consideration (net of liabilities) contributed by the partner to the partnership over the aggregate amount of money and the fair market value of other consideration (net of liabilities) distributed by the partnership to the partner other than transfers of money that are presumed to be guaranteed payments for capital under [paragraph (a)(1)(ii)](#a-1-ii) of this section, transfers of money that are reasonable preferred returns within the meaning of this [paragraph (a)(3)](#a-3), and operating cash flow distributions within the meaning of [paragraph (b)(2)](#b-2) of this section.
  - (4) **Examples.** The following examples illustrate the application of [paragraph (a)](#a) of this section:
- (b) **Presumption regarding operating cash flow distributions—**
  - (1) **In general.** Notwithstanding the presumption set forth in [§ 1.707-3(c)](/cfr/26/1.707-3.md?p=c) (relating to transfers made within two years of each other), an operating cash flow distribution is presumed not to be part of a sale of property to the partnership unless the facts and circumstances clearly establish that the transfer is part of a sale.
  - (2) **Operating cash flow distributions—**
    - (i) **In general.** One or more transfers of money by the partnership to a partner during a taxable year of the partnership are operating cash flow distributions for purposes of [paragraph (b)(1)](#b-1) of this section to the extent that those transfers are not presumed to be guaranteed payments for capital under [paragraph (a)(1)(ii)](#a-1-ii) of this section, are not reasonable preferred returns within the meaning of [paragraph (a)(3)](#a-3) of this section, are not characterized by the parties as distributions to the partner acting in a capacity other than as a partner, and to the extent they do not exceed the product of the net cash flow of the partnership from operations for the year multiplied by the lesser of the partner's percentage interest in overall partnership profits for that year or the partner's percentage interest in overall partnership profits for the life of the partnership. For purposes of the preceding sentence, the net cash flow of the partnership from operations for a taxable year is an amount equal to the taxable income or loss of the partnership arising in the ordinary course of the partnership's business and investment activities, increased by tax exempt interest, depreciation, amortization, cost recovery allowances and other noncash charges deducted in determining such taxable income and decreased by—
      - (A) Principal payments made on any partnership indebtedness;
      - (B) Property replacement or contingency reserves actually established by the partnership;
      - (C) Capital expenditures when made other than from reserves or from borrowings the proceeds of which are not included in operating cash flow; and
      - (D) Any other cash expenditures (including preferred returns) not deducted in determining such taxable income or loss.
    - (ii) **Operating cash flow safe harbor.** For any taxable year, in determining a partner's operating cash flow distributions for the year, the partner may use the partner's smallest percentage interest under the terms of the partnership agreement in any material item of partnership income or gain that may be realized by the partnership in the three-year period beginning with such taxable year. This provision is merely intended to provide taxpayers with a safe harbor and is not intended to preclude a taxpayer from using a different percentage under the rules of [paragraph (b)(2)(i)](#b-2-i) of this section.
    - (iii) **Tiered partnerships.** In the case of tiered partnerships, the upper-tier partnership must take into account its share of the net cash flow from operations of the lower-tier partnership applying principles similar to those described in [paragraph (b)(2)(i)](#b-2-i) of this section, so that the amount of the upper-tier partnership's operating cash flow distributions is neither overstated nor understated.
- (c) **Accumulation of guaranteed payments, preferred returns, and operating cash flow distributions.** Guaranteed payments for capital, preferred returns, and operating cash flow distributions presumed not to be part of a sale under the rules of paragraphs [(a)](#a) and [(b)](#b) of this section do not lose the benefit of the presumption by reason of being retained for distribution in a later year.
- (d) **Exception for reimbursements of preformation expenditures.**
  - (1) **In general.** A transfer of money or other consideration by the partnership to a partner is not treated as part of a sale of property by the partner to the partnership under [§ 1.707-3(a)](/cfr/26/1.707-3.md?p=a) (relating to treatment of transfers as a sale) to the extent that the transfer to the partner by the partnership is made to reimburse the partner for, and does not exceed the amount of, capital expenditures that—
    - (i) Are incurred during the two-year period preceding the transfer by the partner to the partnership; and
    - (ii) **Are incurred by the partner with respect to—**
      - (A) Partnership organization and syndication costs described in [section 709](/cfr/26/709.md); or
      - (B) Property transferred to the partnership by the partner, but only to the extent the reimbursed capital expenditures do not exceed 20 percent of the fair market value of such property at the time of the transfer (the 20-percent limitation). However, the 20-percent limitation of this [paragraph (d)(1)(ii)(B)](#d-1-ii-B) does not apply if the fair market value of the transferred property does not exceed 120 percent of the partner's adjusted basis in the transferred property at the time of the transfer (the 120-percent test). This [paragraph (d)(1)(ii)(B)](#d-1-ii-B) shall be applied on a property-by-property basis, except that a partner may aggregate any of the transferred property under this [paragraph (d)(1)](#d-1) to the extent—

        (1) The total fair market value of such aggregated property (of which no single property's fair market value exceeds 1 percent of the total fair market value of such aggregated property) is not greater than the lesser of 10 percent of the total fair market value of all property, excluding money and marketable securities (as defined under [section 731(c)](/cfr/26/731.md?p=c)), transferred by the partner to the partnership, or $1,000,000;

        (2) The partner uses a reasonable aggregation method that is consistently applied; and

        (3) Such aggregation of property is not part of a plan a principal purpose of which is to avoid [§§ 1.707-3 through 1.707-5](/cfr/26/1.707-3..1.707-5.md).

      - (C) [Reserved].
  - (2) **Capital expenditures incurred by another person.** For purposes of [paragraph (d)(1)](#d-1) of this section, a partner steps in the shoes of a person (to the extent the person was not previously reimbursed under [paragraph (d)(1)](#d-1) of this section) with respect to capital expenditures the person incurred with respect to property transferred to the partnership by the partner to the extent the partner acquired the property from the person in a nonrecognition transaction described in section [351](/cfr/26/351.md), [381(a)](/cfr/26/381.md?p=a), [721](/cfr/26/721.md), or [731](/cfr/26/731.md).
  - (3) **Contribution of a partnership interest with capital expenditures property.** If a person transfers property with respect to which the person incurred capital expenditures (capital expenditures property) to a partnership (lower-tier partnership) and, within the two-year period beginning on the date upon which the person incurred the capital expenditures, transfers an interest in the lower-tier partnership to another partnership (upper-tier partnership) in a nonrecognition transaction under [section 721](/cfr/26/721.md), the upper-tier partnership steps in the shoes of the person who transferred the capital expenditures property to the lower-tier partnership with respect to the capital expenditures that are not otherwise reimbursed to the person. The upper-tier partnership may be reimbursed by the lower-tier partnership under [paragraph (d)(1)](#d-1) of this section to the extent the person could have been reimbursed for the capital expenditures by the lower-tier partnership under [paragraph (d)(1)](#d-1) of this section. In addition, for purposes of [paragraph (d)(1)](#d-1) of this section, the person is deemed to have transferred the capital expenditures property to the upper-tier partnership and may be reimbursed by the upper-tier partnership under [paragraph (d)(1)](#d-1) of this section to the extent the person could have been reimbursed for the capital expenditures by the lower-tier partnership under [paragraph (d)(1)](#d-1) of this section and has not otherwise been previously reimbursed. The aggregate reimbursements for capital expenditures under this [paragraph (d)(3)](#d-3) shall not exceed the amount that the person could have been reimbursed for such capital expenditures under [paragraph (d)(1)](#d-1) of this section.
  - (4) **Special rule for qualified liabilities—**
    - (i) **In general.** For purposes of [paragraph (d)(1)](#d-1) of this section, if capital expenditures were funded by the proceeds of a qualified liability defined in [§ 1.707-5(a)(6)(i)](/cfr/26/1.707-5.md?p=a-6-i) that a partnership assumes or takes property subject to in connection with a transfer of property to the partnership by a partner, a transfer of money or other consideration by the partnership to the partner is not treated as made to reimburse the partner for such capital expenditures to the extent the transfer of money or other consideration by the partnership to the partner exceeds the partner's share of the qualified liability (as determined under § [1.707-5(a)(2)](/cfr/26/1.707-5.md?p=a-2), [(3)](/cfr/26/1.707-5.md?p=a-3), and [(4)](/cfr/26/1.707-5.md?p=a-4)). Capital expenditures are treated as funded by the proceeds of a qualified liability to the extent the proceeds are either traceable to the capital expenditures under [§ 1.163-8T](/cfr/26/1.163-8T.md) or were actually used to fund the capital expenditures, irrespective of the tracing requirements under [§ 1.163-8T](/cfr/26/1.163-8T.md).
    - (ii) **Anti-abuse rule.** If capital expenditures and a qualified liability are incurred under a plan a principal purpose of which is to avoid the requirements of [paragraph (d)(4)(i)](#d-4-i) of this section, the capital expenditures are deemed funded by the qualified liability.
  - (5) **Scope of capital expenditures.** For purposes of this section and [§ 1.707-5](/cfr/26/1.707-5.md), the term capital expenditures has the same meaning as the term capital expenditures has under the Internal Revenue Code and applicable regulations, except that it includes capital expenditures taxpayers elect to deduct, and does not include deductible expenses taxpayers elect to treat as capital expenditures.
  - (6) **Example.** The following example illustrates the application of [paragraph (d)](#d) of this section:
- (e) **Other exceptions.** The Commissioner may provide by guidance published in the Internal Revenue Bulletin that other payments or transfers to a partner are not treated as part of a sale for purposes of [section 707(a)(2)](/cfr/26/707.md?p=a-2) and the regulations thereunder.
- (f) **Ordering rule cross reference.** For payments or transfers by a partnership to a partner to which the rules under this section and [§ 1.707-5(b)](/cfr/26/1.707-5.md?p=b) apply, see the ordering rule under [§ 1.707-5(b)(3)](/cfr/26/1.707-5.md?p=b-3).

# §1.707-5. Disguised sales of property to partnership; special rules relating to liabilities.

- (a) **Liability assumed or taken subject to by partnership—**
  - (1) **In general.** For purposes of this section and §§ [1.707-3](/cfr/26/1.707-3.md) and [1.707-4](/cfr/26/1.707-4.md), if a partnership assumes or takes property subject to a qualified liability (as defined in [paragraph (a)(6)](#a-6) of this section) of a partner, the partnership is treated as transferring consideration to the partner only to the extent provided in [paragraph (a)(5)](#a-5) of this section. By contrast, if the partnership assumes or takes property subject to a liability of the partner other than a qualified liability, the partnership is treated as transferring consideration to the partner to the extent that the amount of the liability exceeds the partner's share of that liability immediately after the partnership assumes or takes subject to the liability as provided in [paragraphs (a)](#a) (2), (3) and (4) of this section.
  - (2) **Partner's share of liability.** A partner's share of any liability of the partnership is determined under the following rules:
    - (i) **Recourse liability.** A partner's share of a recourse liability of the partnership equals the partner's share of the liability under the rules of [section 752](/cfr/26/752.md) and the regulations in this part under [section 752](/cfr/26/752.md). A partnership liability is a recourse liability to the extent that the obligation is a recourse liability under [§ 1.752-1(a)(1)](/cfr/26/1.752-1.md?p=a-1) or would be treated as a recourse liability under that section if it were treated as a partnership liability for purposes of that section.
    - (ii) **Nonrecourse liability.** A partner's share of a nonrecourse liability of the partnership is determined by applying the same percentage used to determine the partner's share of the excess nonrecourse liability under [§ 1.752-3(a)(3)](/cfr/26/1.752-3.md?p=a-3). A partnership liability is a nonrecourse liability of the partnership to the extent that the obligation is a nonrecourse liability under [§ 1.752-1(a)(2)](/cfr/26/1.752-1.md?p=a-2) or would be a nonrecourse liability of the partnership under [§ 1.752-1(a)(2)](/cfr/26/1.752-1.md?p=a-2) if it were treated as a partnership liability for purposes of that section.
  - (3) **Reduction of partner's share of liability.** For purposes of this section, a partner's share of a liability, immediately after a partnership assumes or takes property subject to the liability, is determined by taking into account a subsequent reduction in the partner's share if—
    - (i) At the time that the partnership assumes or takes property subject to the liability, it is anticipated that the transferring partner's share of the liability will be subsequently reduced;
    - (ii) The anticipated reduction is not subject to the entrepreneurial risks of partnership operations; and
    - (iii) The reduction of the partner's share of the liability is part of a plan that has as one of its principal purposes minimizing the extent to which the assumption of or taking property subject to the liability is treated as part of a sale under [§ 1.707-3](/cfr/26/1.707-3.md).
  - (4) **Special rule applicable to transfers of encumbered property to a partnership by more than one partner pursuant to a plan.** For purposes of [paragraph (a)(1)](#a-1) of this section, if the partnership assumes or takes property or properties subject to the liabilities of more than one partner pursuant to a plan, a partner's share of the liabilities assumed or taken subject to by the partnership pursuant to that plan immediately after the transfers equals the sum of that partner's shares of the liabilities (other than that partner's qualified liabilities, as defined in [paragraph (a)(6)](#a-6) of this section) assumed or taken subject to by the partnership pursuant to the plan. This [paragraph (a)(4)](#a-4) does not apply to any liability assumed or taken subject to by the partnership with a principal purpose of reducing the extent to which any other liability assumed or taken subject to by the partnership is treated as a transfer of consideration under [paragraph (a)(1)](#a-1) of this section.
  - (5) **Special rule applicable to qualified liabilities.**
    - (i) If a transfer of property by a partner to a partnership is not otherwise treated as part of a sale, the partnership's assumption of or taking subject to a qualified liability in connection with a transfer of property is not treated as part of a sale. If a transfer of property by a partner to the partnership is treated as part of a sale without regard to the partnership's assumption of or taking subject to a qualified liability (as defined in [paragraph (a)(6)](#a-6) of this section) in connection with the transfer of property, the partnership's assumption of or taking subject to that liability is treated as a transfer of consideration made pursuant to a sale of such property to the partnership only to the extent of the lesser of—
      - (A) The amount of consideration that the partnership would be treated as transferring to the partner under [paragraph (a)(1)](#a-1) of this section if the liability were not a qualified liability; or
      - (B) The amount obtained by multiplying the amount of the qualified liability by the partner's net equity percentage with respect to that property.
    - (ii) A partner's net equity percentage with respect to an item of property equals the percentage determined by dividing—
      - (A) The aggregate transfers of money or other consideration to the partner by the partnership (other than any transfer described in this [paragraph (a)(5)](#a-5)) that are treated as proceeds realized from the sale of the transferred property; by
      - (B) The excess of the fair market value of the property at the time it is transferred to the partnership over any qualified liability encumbering the property or, in the case of any qualified liability described in [paragraph (a)(6)(i)](#a-6-i) (C) or (D) of this section, that is properly allocable to the property.
    - (iii) Notwithstanding [paragraph (a)(5)(i)](#a-5-i) of this section, in connection with a transfer of property by a partner to a partnership that is treated as a sale due solely to the partnership's assumption of or taking property subject to a liability other than a qualified liability, the partnership's assumption of or taking property subject to a qualified liability is not treated as a transfer of consideration made pursuant to the sale if the total amount of all liabilities other than qualified liabilities that the partnership assumes or takes subject to is the lesser of 10 percent of the total amount of all qualified liabilities the partnership assumes or takes subject to, or $1,000,000.
  - (6) **Qualified liability of a partner defined.** A liability assumed or taken subject to by a partnership in connection with a transfer of property to the partnership by a partner is qualified liability of the partner only to the extend—
    - (i) **The liability is—**
      - (A) A liability that was incurred by the partner more than two years prior to the earlier of the date the partner agrees in writing to transfers the property or the date the partner transfers the property to the partnership and that has encumbered the transferred property throughout that two-year period;
      - (B) A liability that was not incurred in anticipation of the transfer of the property to a partnership, buy that was incurred by the partner within the two-year period prior to the earlier of the date the partner agrees in writing to transfer the property or the date the partner transfers the property to the partnership and that has encumbered the transferred property since it was incurred (see [paragraph (a)(7)](#a-7) of this section for further rules regarding a liability incurred within two years of a property transfer or of a written agreement to transfer);
      - (C) A liability that is allocable under the rules of [§ 1.163-8T](/cfr/26/1.163-8T.md) to capital expenditures (as described under [§ 1.707-4(d)(5)](/cfr/26/1.707-4.md?p=d-5)) with respect to the property;
      - (D) A liability that was incurred in the ordinary course of the trade or business in which property transferred to the partnership was used or held but only if all the assets related to that trade or business are transferred other than assets that are not material to a continuation of the trade or business; or
      - (E) A liability that was not incurred in anticipation of the transfer of the property to a partnership, but that was incurred in connection with a trade or business in which property transferred to the partnership was used or held but only if all the assets related to that trade or business are transferred other than assets that are not material to a continuation of the trade or business (see [paragraph (a)(7)](#a-7) of this section for further rules regarding a liability incurred within two years of a transfer presumed to be in anticipation of the transfer); and
    - (ii) If the liability is a recourse liability, the amount of the liability does not exceed the fair market value of the transferred property (less the amount of any other liabilities that are senior in priority and that either encumber such property or are liabilities described in [paragraph (a)(6)(i)](#a-6-i) (C) or (D) of this section) at the time of the transfer.
  - (7) **Liability incurred within two years of transfer presumed to be in anticipation of the transfer—**
    - (i) **In general.** For purposes of this section, if within a two-year period a partner incurs a liability (other than a liability described in [paragraph (a)(6)(i)](#a-6-i) (C) or (D) of this section) and transfers property to a partnership or agrees in writing to transfer the property, and in connection with the transfer the partnership assumes or takes the property subject to the liability, the liability is presumed to be incurred in anticipation of the transfer unless the facts and circumstances clearly establish that the liability was not incurred in anticipation of the transfer.
    - (ii) **Disclosure of transfers of property subject to liabilities incurred within two years of the transfer.** A partner that treats a liability assumed or taken subject to by a partnership in connection with a transfer of property as a qualified liability under [paragraph (a)(6)(i)(B)](#a-6-i-B) of this section or under [paragraph (a)(6)(i)(E)](#a-6-i-E) of this section (if the liability was incurred by the partner within the two-year period prior to the earlier of the date the partner agrees in writing to transfer the property or the date the partner transfers the property to the partnership) must disclose such treatment to the Internal Revenue Service in accordance with [§ 1.707-8](/cfr/26/1.707-8.md).
  - (8) **Liability incurred by another person.** Except as provided in [paragraph (e)(2)](#e-2) of this section, a partner steps in the shoes of a person for purposes of [paragraph (a)](#a) of this section with respect to a liability the person incurred or assumed to the extent the partner assumed or took property subject to the liability from the person in a nonrecognition transaction described in section [351](/cfr/26/351.md), [381(a)](/cfr/26/381.md?p=a), [721](/cfr/26/721.md), or [731](/cfr/26/731.md).
- (b) **Treatment of debt-financed transfers of consideration by partnerships—**
  - (1) **In general.** For purposes of [§ 1.707-3](/cfr/26/1.707-3.md), if a partner transfers property to a partnership, and the partnership incurs a liability and all or a portion of the proceeds of that liability are allocable under [§ 1.163-8T](/cfr/26/1.163-8T.md) to a transfer of money or other consideration to the partner made within 90 days of incurring the liability, the transfer of money or other consideration to the partner is taken into account only to the extent that the amount of money or the fair market value of the other consideration transferred exceeds that partner's allocable share of the partnership liability. For purposes of [paragraph (b)](#b) of this section, an upper-tier partnership's share of the liability of a lower-tier partnership as described under [§ 1.707-5(a)(2)](#a-2) that is treated as a liability of the upper-tier partnership under [§ 1.752-4(a)](/cfr/26/1.752-4.md?p=a) shall be treated as a liability of the upper-tier partnership incurred on the same day the liability was incurred by the lower-tier partnership.
  - (2) **Partner's allocable share of liability—**
    - (i) **In general.** A partner's allocable share of a partnership liability for purposes of [paragraph (b)(1)](#b-1) of this section equals the amount obtained by multiplying the partner's share of the liability as described in [paragraph (a)(2)](#a-2) of this section by the fraction determined by dividing—
      - (A) The portion of the liability that is allocable under [§ 1.163-8T](/cfr/26/1.163-8T.md) to the money or other consideration transferred to the partner; by
      - (B) **The total amount of the liability.**
    - (ii) **Debt-financed transfers made pursuant to a plan—**
      - (A) **In general.** Except as provided in [paragraph (b)(2)(iii)](#b-2-iii) of this section, if a partnership transfers to more than one partner pursuant to a plan all or a portion of the proceeds of one or more partnership liabilities, [paragraph (b)(1)](#b-1) of this section is applied by treating all of the liabilities incurred pursuant to the plan as one liability, and each partner's allocable share of those liabilities equals the amount obtained by multiplying the sum of the partner's shares of each of the respective liabilities (as defined in [paragraph (a)(2)](#a-2) of this section) by the fraction obtained by dividing—

        (1) The portion of those liabilities that is allocable under [§ 1.163-8T](/cfr/26/1.163-8T.md) to the money or other consideration transferred to the partners pursuant to the plan; by

        (2) The total amount of those liabilities.

      - (B) **Special rule.** [Paragraph (b)(2)(ii)(A)](#b-2-ii-A) of this section does not apply to any transfer of money or other property to a partner that is made with a principal purpose of reducing the extent to which any transfer is taken into account under [paragraph (b)(1)](#b-1) of this section.
    - (iii) **Reduction of partner's share of liability.** For purposes of [paragraph (b)(2)](#b-2) of this section, a partner's share of a liability immediately after a partnership incurs the liability is determined by taking into account a subsequent reduction in the partner's share if—
      - (A) At the time that the partnership incurs the liability, it is anticipated that the partner's share of the liability that is allocable to a transfer of money or other consideration to the partner will be reduced subsequent to the transfer;
      - (B) The anticipated reduction is not subject to the entrepreneurial risks of partnership operations; and
      - (C) The reduction of the partner's share of the liability is part of a plan that has as one of its principal purposes minimizing the extent to which the partnership's distribution of the proceeds of the borrowing is treated as part of a sale.
  - (3) **Ordering rule.** The treatment of a transfer of money or other consideration under [paragraph (b)](#b) of this section is determined before applying the rules under [§ 1.707-4](/cfr/26/1.707-4.md).
- (c) **Refinancings.** To the extent that the proceeds of a partner or partnership liability (the refinancing debt) are allocable under the rules of [§ 1.163-8T](/cfr/26/1.163-8T.md) to payments discharging all or part of any other liability of that partner or of the partnership, as the case may be, the refinancing debt is treated as the other liability for purposes of applying the rules of this section.
- (d) **Share of liability where assumption accompanied by transfer of money.** For purposes of [§§ 1.707-3 through 1.707-5](/cfr/26/1.707-3..1.707-5.md), if pursuant to a plan a partner pays or contributes money to the partnership and the partnership assumes or takes subject to one or more liabilities (other than qualified liabilities) of the partner, the amount of those liabilities that the partnership is treated as assuming or taking subject to is reduced (but not below zero) by the money transferred.
- (e) **Tiered partnerships and other related persons.**
  - (1) If a lower-tier partnership succeeds to a liability of an upper-tier partnership, the liability in the lower-tier partnership retains the characterization as qualified or nonqualified that it had under these rules in the upper-tier partnership. A similar rule applies to other related party transactions involving liabilities to the extent provided by guidance published in the Internal Revenue Bulletin.
  - (2) If an interest in a partnership that has one or more liabilities (the lower-tier partnership) is transferred to another partnership (the upper-tier partnership), the upper-tier partnership's share of any liability of the lower-tier partnership that is treated as a liability of the upper-tier partnership under [§ 1.752-4(a)](/cfr/26/1.752-4.md?p=a) is treated as a qualified liability under [paragraph (a)(6)(i)](#a-6-i) of this section to the extent the liability would be a qualified liability under [paragraph (a)(6)(i)](#a-6-i) of this section had the liability been assumed or taken subject to by the upper-tier partnership in connection with a transfer of all of the lower-tier partnership's property to the upper-tier partnership by the lower-tier partnership. For purposes of determining whether the liability constitutes a qualified liability under paragraphs [(a)(6)(i)(B)](#a-6-i-B) and [(E)](#a-6-i-E) of this section, a determination that the liability was not incurred in anticipation of the transfer of property to the upper-tier partnership is based on whether the partner in the lower-tier partnership anticipated transferring its interest in the lower-tier partnership to the upper-tier partnership at the time the liability was incurred by the lower-tier partnership.
- (f) **Examples.** The following examples illustrate the application of this section.
  - (1) **Example 1. Partnership's assumption of nonrecourse liability encumbering transferred property.**
    - (i) A and B form partnership AB, which will engage in renting office space. A transfers $500,000 in cash to the partnership, and B transfers an office building to the partnership. At the time it is transferred to the partnership, the office building has a fair market value of $1,000,000, has an adjusted basis of $400,000, and is encumbered by a $500,000 nonrecourse liability, which B incurred 12 months earlier to finance the acquisition of other property and which the partnership assumed. No facts rebut the presumption that the liability was incurred in anticipation of the transfer of the property to the partnership. Assume that this liability is a nonrecourse liability of the partnership within the meaning of [section 752](/cfr/26/752.md) and the regulations thereunder. The partnership agreement provides that partnership items will be allocated equally between A and B, including excess nonrecourse liabilities under [§ 1.752-3(a)(3)](/cfr/26/1.752-3.md?p=a-3). The partnership agreement complies with the requirements of [§ 1.704-1(b)(2)(ii)(b)](/cfr/26/1.704-1.md?p=b-2-ii-b).
    - (ii) The nonrecourse liability secured by the office building is not a qualified liability within the meaning of [paragraph (a)(6)](#a-6) of this section. B would be allocated 50 percent of the excess nonrecourse liability under the partnership agreement. Accordingly, immediately after the partnership's assumption of that liability, B's share of the liability as determined under [paragraph (a)(2)](#a-2) of this section is $250,000 (B's 50 percent share of the partnership's excess nonrecourse liability as determined in accordance with B's share of partnership profits under [§ 1.752-3(a)(3)](/cfr/26/1.752-3.md?p=a-3)).
    - (iii) The partnership's assumption of the liability encumbering the office building is treated as a transfer of $250,000 of consideration to B (the amount by which the liability ($500,000) exceeds B's share of that liability immediately after the partnership's assumption of the liability ($250,000)). B is treated as having sold $250,000 of the fair market value of the office building to the partnership in exchange for the partnership's assumption of a $250,000 liability. This results in a gain of $150,000 ($250,000 minus ($250,000/$1,000,000 multiplied by $400,000)).
  - (2) **Example 2. Partnership's assumption of recourse liability encumbering transferred property—** . (i) C transfers property Y to a partnership. At the time of its transfer to the partnership, property Y has a fair market value of $10,000,000 and is subject to an $8,000,000 liability that C incurred, immediately before transferring property Y to the partnership, in order to finance other expenditures. Upon the transfer of property Y to the partnership, the partnership assumed the liability encumbering that property. The partnership assumed this liability solely to acquire property Y. Under [section 752](/cfr/26/752.md) and the regulations in this part under [section 752](/cfr/26/752.md), immediately after the partnership's assumption of the liability encumbering property Y, the liability is a recourse liability of the partnership and C's share of that liability is $7,000,000.
    - (ii) Under the facts of paragraph (f)(2)(i) of this section (Example 2), the liability encumbering property Y is not a qualified liability. Accordingly, the partnership's assumption of the liability results in a transfer of consideration to C in connection with C's transfer of property Y to the partnership in the amount of $1,000,000 (the excess of the liability assumed by the partnership ($8,000,000) over C's share of the liability immediately after the assumption ($7,000,000)). See paragraphs [(a)(1)](#a-1) and [(2)](#a-2) of this section.
  - (3) **Example 3. Subsequent reduction of transferring partner's share of liability—** . (i) The facts are the same as in [paragraph (f)(2)](#f-2) of this section (Example 2). In addition, property Y is a fully leased office building, the rental income from property Y is sufficient to meet debt service, and the remaining term of the liability is ten years. It is anticipated that, three years after the partnership's assumption of the liability, C's share of the liability under [section 752](/cfr/26/752.md) will be reduced to zero because of a shift in the allocation of partnership losses pursuant to the terms of the partnership agreement. Under the partnership agreement, this shift in the allocation of partnership losses is dependent solely on the passage of time.
    - (ii) Under [paragraph (a)(3)](#a-3) of this section, if the reduction in C's share of the liability was anticipated at the time of C's transfer, was not subject to the entrepreneurial risks of partnership operations, and was part of a plan that has as one of its principal purposes minimizing the extent of sale treatment under [§ 1.707-3](/cfr/26/1.707-3.md) (that is, a principal purpose of allocating a large percentage of losses to C in the first three years when losses were not likely to be realized was to minimize the extent to which C's transfer would be treated as part of a sale), C's share of the liability immediately after the assumption is treated as equal to C's reduced share.
  - (4) **Example 4. Trade payables as qualified liabilities.**
    - (i) D and E form partnership DE which will engage in a consulting business that requires no overhead and minimal cash on hand for daily operating expenses. Previously, D and E, as individual sole proprietors, operated separate consulting businesses. D and E each transfer to the partnership sufficient cash to cover daily operating expenses together with the goodwill and trade payables related to each sole proprietorship. Due to uncertainty over the collection rate on the trade receivables related to their sole proprietorships, D and E agree that none of the trade receivables will be transferred to the partnership.
    - (ii) Under the facts of this example, all the assets related to the consulting business (other than the trade receivables) together with the trade payables were transferred to partnership DE. The trade receivables retained by D and E are not material to a continuation of the trade or business by the partnership because D and E contributed sufficient cash to cover daily operating expenses. Accordingly, the trade payables transferred to the partnership constitute qualified liability under [paragraph (a)(6)](#a-6) of this section.
  - (5) **Partnership's assumption of a qualified liability as sole consideration.**
    - (i) **F purchases property Z in 2012.** In 2017, F transfers property Z to a partnership. At the time of its transfer to the partnership, property Z has a fair market value of $165,000 and an adjusted tax basis of $75,000. Also, at the time of the transfer, property Z is subject to a $75,000 nonrecourse liability that F incurred more than two years before transferring property Z to the partnership. The liability has been secured by property Z since it was incurred by F. Upon the transfer of property Z to the partnership, the partnership assumed the liability encumbering that property. The partnership made no other transfers to F in consideration for the transfer of property Z to the partnership. Assume that immediately after the partnership's assumption of the liability encumbering property Z, F's share of that liability for disguised sale purposes is $25,000 in accordance with [§ 1.707-5(a)(2)](#a-2).
    - (ii) The $75,000 liability secured by property Z is a qualified liability of F because F incurred the liability more than two years prior to the partnership's assumption of the liability and the liability has encumbered property Z for more than two years prior to F's transfer. See [paragraph (a)(6)](#a-6) of this section. Therefore, since no other transfer to F was made as consideration for the transfer of property Z, under [paragraph (a)(5)](#a-5) of this section, the partnership's assumption of the qualified liability of F encumbering property Z is not treated as part of a sale.
  - (6) **Example 6. Partnership's assumption of a qualified liability in addition to other consideration.**
    - (i) The facts are the same as in [paragraph (f)(5)](#f-5) of this section (Example 5), except that the partnership makes a transfer to F of $30,000 in money that is consideration for F's transfer of property Z to the partnership under [§ 1.707-3](/cfr/26/1.707-3.md).
    - (ii) As in [paragraph (f)(5)](#f-5) of this section (Example 5), the $75,000 liability secured by property Z is a qualified liability of F. Since the partnership transferred $30,000 to F in addition to assuming the qualified liability under [paragraph (a)(5)](#a-5) of this section, assuming no other exception to disguised sale treatment applies to the transfer of the $30,000, the partnership's assumption of this qualified liability is treated as a transfer of additional consideration to F to the extent of the lesser of—
      - (A) The amount that the partnership would be treated as transferring to F if the liability were not a qualified liability ($50,000 (that is, the excess of the $75,000 qualified liability over F's $25,000 share of that liability)); or
      - (B) The amount obtained by multiplying the qualified liability ($75,000) by F's net equity percentage with respect to property Z (one-third).
    - (iii) **F's net equity percentage with respect to property Z equals the fraction determined by dividing—**
      - (A) The aggregate amount of money or other consideration (other than the qualified liability) transferred to F and treated as part of a sale of property Z under [§ 1.707-3(a)](/cfr/26/1.707-3.md?p=a) ($30,000 transfer of money); by
      - (B) F's net equity in property Z ($90,000 (that is, the excess of the $165,000 fair market value over the $75,000 qualified liability)).
    - (iv) Accordingly, the partnership's assumption of the qualified liability of F encumbering property Z is treated as a transfer of $25,000 (one-third of $75,000) of consideration to F pursuant to a sale. Therefore, F is treated as having sold $55,000 of the fair market value of property Z to the partnership in exchange for $30,000 in money and the partnership's assumption of $25,000 of the qualified liability. Accordingly, F must recognize $30,000 of gain on the sale (the excess of the $55,000 amount realized over $25,000 of F's adjusted basis for property Z (that is, one-third of F's adjusted basis for the property, because F is treated as having sold one-third of the property to the partnership)).
  - (7) **Example 7. Partnership's assumptions of liabilities encumbering properties transferred pursuant to a plan—** . (i) Pursuant to a plan, G and H transfer property 1 and property 2, respectively, to an existing partnership in exchange for interests in the partnership. At the time the properties are transferred to the partnership, property 1 has a fair market value of $10,000 and an adjusted tax basis of $6,000, and property 2 has a fair market value of $10,000 and an adjusted tax basis of $4,000. At the time properties 1 and 2 are transferred to the partnership, a $6,000 nonrecourse liability (liability 1) is secured by property 1 and a $7,000 recourse liability of F (liability 2) is secured by property 2. Properties 1 and 2 are transferred to the partnership, and the partnership takes subject to liability 1 and assumes liability 2. G and H incurred liabilities 1 and 2 immediately prior to transferring properties 1 and 2 to the partnership and used the proceeds for personal expenditures. The liabilities are not qualified liabilities. Assume that G and H are each allocated $2,000 of liability 1 in accordance with [paragraph (a)(2)(ii)](#a-2-ii) of this section (which determines a partner's share of a nonrecourse liability). Assume further that G's share of liability 2 is $3,500 and H's share is $0 in accordance with [paragraph (a)(2)(i)](#a-2-i) of this section (which determines a partner's share of a recourse liability).
    - (ii) **G and H transferred properties 1 and 2 to the partnership pursuant to a plan.** Accordingly, the partnership's taking subject to liability 1 is treated as a transfer of only $500 of consideration to G (the amount by which liability 1 ($6,000) exceeds G's share of liabilities 1 and 2 ($5,500)), and the partnership's assumption of liability 2 is treated as a transfer of only $5,000 of consideration to H (the amount by which liability 2 ($7,000) exceeds H's share of liabilities 1 and 2 ($2,000)). G is treated under the rule in [§ 1.707-3](/cfr/26/1.707-3.md) as having sold $500 of the fair market value of property 1 in exchange for the partnership's taking subject to liability 1 and H is treated as having sold $5,000 of the fair market value of property 2 in exchange for the assumption of liability 2.
  - (8) **Example 8. Partnership's assumption of liability pursuant to a plan to avoid sale treatment of partnership assumption of another liability—** . (i) The facts are the same as in [paragraph (f)(7)](#f-7) of this section (Example 7), except that—
    - (A) H transferred the proceeds of liability 2 to the partnership; and
    - (B) H incurred liability 2 in an attempt to reduce the extent to which the partnership's taking subject to liability 1 would be treated as a transfer of consideration to G (and thereby reduce the portion of G's transfer of property 1 to the partnership that would be treated as part of a sale).
    - (ii) Because the partnership assumed liability 2 with a principal purpose of reducing the extent to which the partnership's taking subject to liability 1 would be treated as a transfer of consideration to G, liability 2 is ignored in applying [paragraph (a)(3)](#a-3) of this section. Accordingly, the partnership's taking subject to liability 1 is treated as a transfer of $4,000 of consideration to G (the amount by which liability 1 ($6,000) exceeds G's share of liability 1 ($2,000)). On the other hand, the partnership's assumption of liability 2 is not treated as a transfer of any consideration to H because H's share of that liability equals $7,000 as a result of H's transfer of $7,000 in money to the partnership.
  - (9) **Example 9. Partnership's assumptions of qualified liabilities encumbering properties transferred pursuant to a plan in addition to other consideration.**
    - (i) Pursuant to a plan, I transfers property 1 and J transfers property 2 plus $10,000 in cash to partnership IJ in exchange for equal interests in the partnership. At the time the properties are transferred to the partnership, property 1 has a fair market value of $100,000, an adjusted tax basis of $5,000, and is encumbered by a qualified liability of $50,000 (liability 1). Property 2 has a fair market value of $100,000, an adjusted tax basis of $5,000, and is encumbered by a qualified liability of $70,000 (liability 2). Pursuant to the plan, the partnership transferred to I $10,000 in cash. That amount is consideration for I's transfer of property 1 to the partnership under [§ 1.707-3](/cfr/26/1.707-3.md). In accordance with [§ 1.707-5(a)(2)](#a-2), I and J are each allocated $25,000 of liability 1 and $35,000 of liability 2.
    - (ii) Because the partnership transferred $10,000 to I as consideration for the transfer of property, under [§ 1.707-5(a)(5)](#a-5), the partnership's assumption of liability 1 is treated as a transfer of additional consideration to I, even though liability 1 is a qualified liability, to the extent of the lesser of—
      - (A) The amount that the partnership would be treated as transferring to I if the liability were not a qualified liability; or
      - (B) The amount obtained by multiplying the qualified liability by I's net equity percentage with respect to property 1.
    - (iii) Because I and J transferred properties 1 and 2 to the partnership pursuant to a plan, treating I's qualified liability as a nonqualified liability under [§ 1.707-5(a)(5)(i)(A)](#a-5-i-A) enables I to apply the special rule applicable to transfers of encumbered property to a partnership by more than one partner pursuant to a plan under [§ 1.707-5(a)(4)](#a-4). Under this alternative test, the partnership's assumption of liability 1 encumbering property 1 is treated as a transfer of zero ($0) additional consideration to I pursuant to a sale. This is because the amount of liability 1 ($50,000) does not exceed the sum of I's share of liability 1 treated as a nonqualified liability ($25,000) and I's share of liability 2 ($35,000)).
    - (iv) The alternative under [§ 1.707-5(a)(5)(i)(B)](#a-5-i-B) is the amount obtained by multiplying the qualified liability ($50,000) by I's net equity percentage with respect to property 1. I's net equity percentage with respect to property 1 equals one-fifth, the fraction determined by dividing—
      - (A) The aggregate amount of money or other consideration (other than the qualified liability) transferred to I and treated as part of a sale of property 1 under [§ 1.707-3(a)](/cfr/26/1.707-3.md?p=a) (the $10,000 transfer of money; by
      - (B) I's net equity in property 1 ($50,000 i.e., the excess of the $100,000 fair market value over the $50,000 qualified liability).
    - (v) Under this alternative test, the partnership's assumption of the qualified liability encumbering property 1 is treated as a transfer of $10,000 (one-fifth of the $50,000 qualified liability) of additional consideration to I pursuant to a sale.
    - (vi) Applying [§ 1.707-5(a)(5)](#a-5) to these facts, the partnership's assumption of liability 1 is treated as a transfer of additional consideration to I to the extent of the lesser of—
      - (A) zero; or
      - (B) $10,000.
    - (vii) Therefore, the partnership's assumption of I's qualified liability encumbering property 1 is not treated as a transfer of any additional consideration to I pursuant to a sale, and I is treated as having only received $10,000 of the fair market value of property 1 to the partnership in exchange for $10,000 in cash. Accordingly, I must recognize $9,500 of gain on the sale, that is, the excess of the $10,000 amount realized over $500 of I's adjusted tax basis for property 1 (one-tenth of I's adjusted tax basis for the property, because I is treated as having sold one-tenth of the property to the partnership). Since no other transfer to J was made as consideration for the transfer of property 2, the partnership's assumption of the qualified liability of J encumbering property 2 is not treated as part of a sale.
  - (10) **Example 10. Treatment of debt-financed transfers of consideration by partnership.**
    - (i) K transfers property Z to partnership KL in exchange for a 50 percent interest therein on April 9, 2017. On September 13, 2017, the partnership incurs a nonrecourse liability of $20,000. On November 17, 2017, the partnership transfers $20,000 to K, and $10,000 of this transfer is allocable under the rules of [§ 1.163-8T](/cfr/26/1.163-8T.md) to proceeds of the partnership liability incurred on September 13, 2017. The remaining $10,000 is paid from other partnership funds. Assume that on November 17, 2017, for disguised sale purposes, K's share of the $20,000 liability incurred on September 13, 2017, is $10,000 in accordance with [§ 1.707-5(a)(2)](#a-2).
    - (ii) Because a portion of the transfer made to K on November 17, 2017, is allocable under [§ 1.163-8T](/cfr/26/1.163-8T.md) to proceeds of a partnership liability that was incurred by the partnership within 90 days of that transfer, K is required to take the transfer into account in applying the rules of this section and [§ 1.707-3](/cfr/26/1.707-3.md) only to the extent that the amount of the transfer exceeds K's allocable share of the liability used to fund the transfer. K's allocable share of the $20,000 liability used to fund $10,000 of the transfer to K is $5,000 (K's share of the liability ($10,000) multiplied by the fraction obtained by dividing—
      - (A) The amount of the liability that is allocable to the distribution to K ($10,000); by
      - (B) **The total amount of such liability ($20,000)).**
    - (iii) Therefore, K is required to take into account $15,000 of the $20,000 partnership transfer to K for purposes of this section and [§ 1.707-3](/cfr/26/1.707-3.md). Under these facts, assuming no other exception applies and the within-two-year presumption is not rebutted, this $15,000 transfer will be treated under the rule in [§ 1.707-3](/cfr/26/1.707-3.md) as part of a sale by K of property Z to the partnership.
  - (11) **Example 11. Treatment of debt-financed transfers of consideration and transfers characterized as guaranteed payments by a partnership.**
    - (i) The facts are the same as in [paragraph (f)(10)](#f-10) of this section (Example 10) except that the entire $20,000 transfer to K is allocable under the rules of [§ 1.163-8T](/cfr/26/1.163-8T.md) to proceeds of the partnership liability incurred on September 13, 2017. In addition, the partnership agreement provides that K is to receive a guaranteed payment for the use of K's capital in the amount of $10,000 in each of the three years following the transfer of property Z. Ten thousand dollars of the transfer made to K on November 17, 2017, is pursuant to this provision of the partnership agreement. Assume that the guaranteed payment to K constitutes a reasonable guaranteed payment within the meaning of [§ 1.707-4(a)(3)](/cfr/26/1.707-4.md?p=a-3).
    - (ii) Under these facts, the rules under both [§ 1.707-4(a)](/cfr/26/1.707-4.md?p=a) and [§ 1.707-5(b)](#b) apply to the November 17, 2017 transfer to K by the partnership. Thus, the ordering rule in [§ 1.707-5(b)(3)](#b-3) requires that the [§ 1.707-5(b)](#b) debt-financed distribution rules apply first to determine the treatment of the $20,000 transfer. Because the entire transfer made to K on November 17, 2017, is allocable under [§ 1.163-8T](/cfr/26/1.163-8T.md) to proceeds of a partnership liability that was incurred by the partnership within 90 days of that transfer, K is required to take the transfer into account in applying the rules of this section and [§ 1.707-3](/cfr/26/1.707-3.md) only to the extent that the amount of the transfer exceeds K's allocable share of the liability used to fund the transfer. K's allocable share of the $20,000 liability used to fund the transfer to K is $10,000 (K's share of the liability ($10,000) multiplied by the fraction obtained by dividing—
      - (A) The amount of the liability that is allocable to the distribution to K ($20,000); by
      - (B) **The total amount of such liability ($20,000)).**
    - (iii) The remaining $10,000 amount of the transfer to K that exceeds K's allocable share of the liability is tested to determine whether an exception under [§ 1.707-4](/cfr/26/1.707-4.md) applies. Because $10,000 of the payment to K is a reasonable guaranteed payment for capital under [§ 1.707-4(a)(1)(ii)](/cfr/26/1.707-4.md?p=a-1-ii), the $10,000 transfer will not be treated as part of a sale by K of property Z to the partnership under [§ 1.707-3](/cfr/26/1.707-3.md).
  - (12) **Example 12. Treatment of debt-financed transfers of consideration by partnership made pursuant to plan.**
    - (i) O transfers property X, and P transfers property Y, to partnership OP in exchange for equal interests therein on June 1, 2017. On October 1, 2017, the partnership incurs two nonrecourse liabilities: Liability 1 of $8,000 and Liability 2 of $4,000. On December 15, 2017, the partnership transfers $2,000 to each of O and P pursuant to a plan. The transfers made to O and P on December 15, 2017 are allocable under [§ 1.163-8T](/cfr/26/1.163-8T.md) to the proceeds of either Liability 1 or Liability 2. Assume that under [§ 1.707-5(a)(2)](#a-2), O's and P's share of Liability 1 is $4,000 each and of Liability 2 is $2,000 each on December 15, 2017.
    - (ii) Because the partnership transferred pursuant to a plan a portion of the proceeds of the two liabilities to O and P, [paragraph (b)(1)](#b-1) of this section is applied by treating Liability 1 and Liability 2 as a single $12,000 liability. Pursuant to [paragraph (b)(2)(ii)(A)](#b-2-ii-A) of this section, each partner's allocable share of the $12,000 liability equals the amount obtained by multiplying the sum of the partner's share of Liability 1 and Liability 2 ($6,000) ($4,000 for Liability 1 plus $2,000 for Liability 2) by the fraction obtained by dividing—
      - (A) The amount of the liability that is allocable to the distribution to O and P pursuant to the plan ($4,000); by
      - (B) **The total amount of such liability ($12,000).**
    - (iii) **Therefore, O's and P's allocable share of the $12,000 liability is $2,000 each.** Accordingly, because a portion of the proceeds of the $12,000 liability are allocable under [§ 1.163-8T](/cfr/26/1.163-8T.md) to the $2,000 transfer made to each of O and P within 90 days of incurring the liability, and the $2,000 transfer does not exceed O's or P's $2,000 allocable share of that liability, each is required to take into account $0 of the $2,000 transfer for purposes of this section and [§ 1.707-3](/cfr/26/1.707-3.md). Under these facts, no part of the transfers to O and P will be treated as part of a sale of property X by O or of property Y by P. (13) Example 13. Borrowing against pool of receivables. (i) M generates receivables which have an adjusted basis of zero in the ordinary course of its business. For M to use receivables as security for a loan, a commercial lender requires M to transfer the receivables to a partnership in which M has a 90 percent interest. In January, 1992, M transfers to the partnership receivables with a face value of $100,000. N (who is not related to M) transfers $10,000 cash to the partnership in exchange for a 10 percent interest. The partnership borrows $80,000, secured by the receivables, and makes a distribution of $72,000 of the proceeds to M and $8,000 of the proceeds to N within 90 days of incurring the liability. M's share of the liability under [§ 1.707-5(a)(2)](#a-2) is $72,000 (90 percent × $80,000).
    - (ii) Because the transfer of the loan proceeds to M is allocable under [§ 1.163-8T](/cfr/26/1.163-8T.md) to proceeds of a partnership loan that was incurred by the partnership within 90 days of that transfer, M is required to take the transfer into account in applying the rules of this section and [§ 1.707-3](/cfr/26/1.707-3.md) only to the extent that the amount of the transfer ($72,000) exceeds M's allocable share of the liability used to fund the transfer. Because the distribution was a debt-financed transfer pursuant to a plan, M's allocable share of the liability is $72,000 ($72,000 × $80,000/80,000) under [§ 1.707-5(b)(2)(ii)](#b-2-ii). Therefore, M is not required to take into account any of the loan proceeds for purposes of this section and [§ 1.707-3](/cfr/26/1.707-3.md).
    - (iii) When the receivables are collected, M must be allocated the gain on the contributed receivables under [section 704(c)](/cfr/26/704.md?p=c). However, the lender permits the partnership to distribute cash to the partners only to the extent of the value of new receivables contributed to the partnership. In 1993, M contributes additional receivables and receives a distribution of cash. The taxable income recognized by the partnership on the receivables is taxable income of the partnership arising in the ordinary course of the partnership's activities. To the extent the distribution does not exceed 90 percent (M's percentage interest in overall partnership profits) of the partnership's operating cash flow under [§ 1.707-4(b)](/cfr/26/1.707-4.md?p=b), the distribution to M is presumed not to be a part of a sale of receivables by M to the partnership, and the presumption is not rebutted under these facts.