What does qualified nonrecourse financing mean on the CPA exam?
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Qualified nonrecourse financing. Borrowing secured by real property from a commercial lender, where nobody is personally liable. It counts toward a partner's at-risk amount even though the debt is nonrecourse.
Defined against Sec. 465(b)(6).
Worked example
Dana owns 20% of a partnership that buys an apartment building and leases out the units. Her at-risk amount at the start of the year is her $40,000 cash contribution. During the year the partnership borrows $500,000 from an unrelated commercial bank. The building is the only collateral, no partner is personally liable, and the loan cannot be converted into an equity interest. Dana's share of the loan follows her 20% interest, and her share of the partnership's loss for the year is $165,000.
How much of Dana's loss clears the at-risk limit, and how much is suspended?
| Dana's share of the bank loan, which counts as at risk because it is qualified nonrecourse financing500,000 x 20% | 100,000 |
| At-risk amount before the loss40,000 + 100,000 | 140,000 |
| Loss suspended under the at-risk rules165,000 - 140,000 | 25,000 |
Answer: $140,000 of the loss clears the at-risk limit and $25,000 is suspended, carrying forward until her at-risk amount rises. Her basis, which also includes her share of the loan, is the same $140,000, so the basis limit does not bind first. The passive activity rules then apply to the $140,000 on their own.
The trap: Treating the bank loan like any other nonrecourse debt, which adds nothing to the at-risk amount. Financing secured by real property, from a commercial lender, with nobody personally liable is the exception. Without it Dana would be at risk for only $40,000 and $125,000 of the loss would be suspended.
Based on IRC Sec. 465(b)(6); IRC Sec. 465(a)(2).
Which CPA exam sections use qualified nonrecourse financing?
Qualified nonrecourse financing appears in the REG section of the CPA exam.
Related terms
- at-risk amount: How much a taxpayer could actually lose in an activity: cash and property contributed, plus debt they are personally liable for.
- real property: Land and anything permanently attached to it, such as a building.
- limited partnership: A partnership with at least one general partner who manages and is personally liable, and limited partners who invest without personal liability or control.
- outside basis: A partner's tax basis in the partnership interest itself.
- capital asset: For tax, almost everything a taxpayer owns EXCEPT inventory, receivables, and depreciable or real property used in a trade or business.
- like-kind exchange: A swap of real property held for business or investment, where gain is deferred rather than recognized.