Nonrecourse Debt

An investor contributes $20,000 cash to a limited partnership and personally guarantees repayment of $5,000 of the partnership's recourse bank debt. The partnership separately carries $50,000 of nonrecourse debt that does not meet the definition of qualified nonrecourse financing. What is the investor's at-risk amount? (Figures are illustrative only.)

1. A.$75,000, because all partnership-level debt is included regardless of recourse.Wrong. This adds the full $50,000 of nonqualified nonrecourse debt into at-risk basis, but that debt fails the qualified-nonrecourse-financing exception and stays excluded.
2. B.$20,000, counting only the cash contribution.Wrong. This captures the cash contribution but drops the $5,000 of recourse debt the investor personally guaranteed, which belongs in the at-risk amount.
3. C.$5,000, counting only the guaranteed recourse debt.Wrong. This counts only the guaranteed recourse debt and omits the $20,000 cash contribution, which is also part of at-risk basis.
4. D.$25,000.Correct. At-risk basis is the $20,000 contributed plus the $5,000 of recourse debt personally guaranteed; the nonqualified nonrecourse debt is excluded.

Why: At-risk basis totals what the partner has actually put at economic risk: the $20,000 cash contribution plus the $5,000 of partnership debt the investor personally guaranteed, for $25,000. The $50,000 of nonrecourse debt does not count because it fails the qualified-nonrecourse-financing exception and no partner is personally liable for it, so it sits outside the at-risk computation entirely regardless of its size. If that $50,000 had instead been secured by real property from an unrelated qualified lender, it would be added in as qualified nonrecourse financing and the at-risk amount would rise to $75,000.

A borrower stops paying on a loan held by a mortgage program. What bounds the program's ultimate recovery on that loan?

1. A.The interest that had accrued on the loan before the borrower stopped payingWrong. Accrued interest measures part of what is owed, not what can actually be collected.
2. B.The total capital the limited partners contributed to the programWrong. Investor contributions size the program and say nothing about recovery on any one loan.
3. C.The value realized on the collateral plus any recourse the program has against the borrowerCorrect. A creditor collects out of the security first and out of a personal claim only if it has one.
4. D.The face amount of the loan, collectible in full from the borrower's other assetsWrong. That assumes both full recourse and a solvent borrower, neither of which follows from a default.

Why: The benefit the outline assigns to a mortgage program is predictable income, and the paired risk is default by the borrower. On default the program stops being an income investor and becomes a creditor, and a creditor's recovery is limited by what the security is worth plus whatever personal claim the loan documents give it. Where the loan is nonrecourse, the collateral is the whole of the remedy. That is why the value of the underlying property matters intensely to a mortgage program even though the program never owned the property.

For purposes of the at-risk loss limitation, a limited partner's at-risk amount is best described as which of the following?

1. A.The fair market value of the partner's limited partnership units on the last day of the tax year.Wrong. Fair market value of the units has no role in computing at-risk basis; at-risk basis tracks contributed capital and personal liability exposure, not what the interest could sell for.
2. B.The partner's total share of all partnership liabilities, recourse and nonrecourse alike.Wrong. Ordinary nonrecourse debt is excluded from the at-risk amount because the partner bears no personal obligation to repay it if the venture fails.
3. C.The partner's cash and property contributed to the partnership, plus any partnership liabilities the partner is personally obligated to repay.Correct. At-risk basis is real economic exposure: what the partner put in, plus debt the partner is personally on the hook to repay.
4. D.The partner's original cost basis reduced by cumulative depreciation claimed on the partnership's assets.Wrong. This describes adjusted tax basis used to compute gain or loss on a sale, a related but separate figure from the at-risk amount used to cap deductible losses.

Why: The at-risk amount governs how much loss a partner may currently deduct and is built from real economic exposure: cash and property contributed, plus any partnership debt for which the partner is personally liable if the partnership defaults. Ordinary nonrecourse debt is excluded because the partner has no personal obligation to repay it -- the lender's only recourse is the collateral. Option 2 describes regular basis under the general partnership-taxation rules, which is broader than the at-risk amount and is exactly the confusion this item is testing. If the debt were qualified nonrecourse financing secured by real property, it would count even though nonrecourse, but that is a distinct, narrower exception, not the general rule.

A sponsor sells a warehouse to its own real estate limited partnership and takes back a nonrecourse note secured by the property for part of the purchase price. No partner is personally liable on the note. Does this debt increase the limited partners' at-risk amounts as qualified nonrecourse financing?

1. A.Yes, because it is nonrecourse debt secured by real property, which is exactly what the exception requires.Wrong. Nonrecourse and secured by real property are only two of the three requirements; a related-party lender like the sponsor still fails the exception.
2. B.Yes, but only up to the fair market value of the warehouse on the date of sale.Wrong. The exception does not exist here at all, so there is no partial amount to cap by the property's fair market value.
3. C.No, because qualified nonrecourse financing must come from a bank or similarly unrelated qualified lender, not from the seller or another related party.Correct. Sponsor or seller financing is related-party financing, which the qualified-nonrecourse-financing exception specifically excludes regardless of the other terms.
4. D.No, because seller financing is always treated as a capital contribution rather than debt.Wrong. Seller-financed notes remain debt of the partnership for tax purposes; they are not recharacterized as a capital contribution.

Why: Qualified nonrecourse financing must be nonrecourse, secured by real property, and owed to a bank, insurance company, government entity, or other lender in the business of lending money that is not the seller of the property, the sponsor, or another related party. Seller or sponsor financing fails that third leg even when it is genuinely nonrecourse and secured by the real estate, so it does not add to the limited partners' at-risk amounts. The purpose is to prevent a sponsor from manufacturing paper losses for investors by lending against a property it controls; if the same note had instead come from an outside commercial bank on arm's-length terms, it would qualify.