Leveraged Partnership Sale: Contributing Property and Taking Loan Proceeds Instead of Selling

How the structure works

Partnerships are generally allowed to receive property without tax (IRC 721), and a partner who receives money from a partnership is taxed only when the money exceeds basis (IRC 731). The disguised sale rules stop the obvious abuse: if you contribute property and the partnership pays you, the two steps can be recharacterized as a sale (IRC 707(a)(2)(B)).

The leveraged partnership relies on an exception. When the partnership borrows and distributes the loan proceeds to you within 90 days, the distribution is counted as sale consideration only to the extent it exceeds your allocable share of that liability (Treas. Reg. 1.707-5(b)(1)). If you are allocated the whole loan, the whole distribution is outside the sale rules. You hold cash, the buyer controls the property through the partnership, and your gain stays deferred, carried in your partnership interest.

Why your share of the debt has to be real

Your allocable share of a recourse liability follows the IRC 752 rules, which ask who bears the economic risk of loss if the partnership could not pay (Treas. Reg. 1.707-5(a)(2)(i); Treas. Reg. 1.752-2). That usually means a payment obligation or indemnity from you. Three guardrails decide whether it counts:

• Bottom-dollar payment obligations are disregarded. An obligation that only pays if the lender's recovery falls below some floor, rather than from the first dollar of loss, is not recognized (Treas. Reg. 1.752-2(b)(3)(ii)(C); T.D. 9877, October 9, 2019), and must be disclosed on Form 8275 when undertaken.
• Anti-abuse rule. An obligation can be disregarded if the facts show a plan to create the appearance of risk without the substance (Treas. Reg. 1.752-2(j)).
• Planned reductions count now. If it is anticipated that your share of the debt will later be reduced as part of a plan to avoid sale treatment, your share is measured after that reduction (Treas. Reg. 1.707-5(a)(3) and (b)(2)(iii)).

A nonrecourse loan is shared using the excess nonrecourse liability percentage (Treas. Reg. 1.707-5(a)(2)(ii)), which rarely gives the contributing partner enough of the debt on its own.

Canal Corp.: how it failed

In Canal Corp. v. Commissioner, 135 T.C. 199 (2010), a subsidiary of Chesapeake contributed its tissue business to a joint venture LLC with Georgia-Pacific and received a $755 million distribution funded by a bank loan. Georgia-Pacific stood behind the loan, and the subsidiary agreed to indemnify Georgia-Pacific for any principal it had to pay. The Tax Court found the indemnity created no more than a remote possibility of payment, disregarded it under the 1.752-2(j) anti-abuse rule, held the transaction a disguised sale requiring recognition of a $524 million gain in 1999, and sustained a substantial understatement penalty under IRC 6662(a). Reliance on a favorable tax opinion did not establish reasonable cause.

The lessons for a property owner: the party carrying the debt risk has to be able to pay, the risk has to be real for the life of the arrangement, and an opinion letter is not a shield if the facts do not match it.

Worked example: what is at stake

A cash sale of our couple's California building costs $2,315,474 in 2026 federal, net investment income and California tax. In a leveraged partnership that works, they receive $6,000,000 of loan proceeds and owe nothing now; the deferred gain stays in their partnership interest.

If the structure is recast as a disguised sale of 60% of the building, the tax is $1,385,074, of which $449,139 is California tax, plus interest and potentially a 20% accuracy-related penalty on the underpayment (IRC 6662). The difference between $2,315,474 and $1,385,074 only reflects that a partial sale taxes part of the gain; the rest remains deferred and comes due later. Numbers are illustrative engine output from labeled assumptions, not an assessment of any real transaction.

What the owner gives up

• Control and liquidity. You remain a partner with the buyer, usually a minority partner, under an operating agreement you will live with for years.
• Debt risk. For the deferral to hold, you must bear real risk on the loan. If the partnership cannot pay, your payment obligation or indemnity is called.
• Built-in gain stays with you. Gain on the contributed property is allocated to you when the partnership sells it (IRC 704(c)), and distributions of the property to other partners or of other property to you within seven years can trigger it (IRC 704(c)(1)(B); IRC 737).
• Debt shifts trigger gain. A later reduction in your share of the liabilities is treated as a cash distribution (IRC 752(b)) and can produce gain.
• Disclosure. Transfers within two years that are not reported as a sale generally require disclosure (Treas. Reg. 1.707-3(c)(2); Treas. Reg. 1.707-8).

How it compares with other ways to defer

A 1031 exchange defers gain if you buy other real estate, and a 721 UPREIT contribution defers it if you take operating partnership units in a REIT. A Section 453 installment sale spreads the gain as the buyer pays, with buyer credit risk you secure with a down payment and a first-position deed of trust; it cannot spread recapture (IRC 453(i)). The leveraged partnership is the only one of these that puts loan cash in your hands at closing while you keep debt risk and a long-term partnership with the buyer.

Do not confuse it with structures the IRS treats as abusive. The monetized installment sale is the subject of proposed regulations to make it a listed transaction (REG-109348-22, August 4, 2023). Syndicated conservation easements have been listed since Notice 2017-10, certain micro-captive arrangements are listed or transactions of interest under T.D. 10029 (January 2025), and charitable remainder annuity trust schemes that buy a commercial annuity with the sale proceeds were identified as listed transactions in T.D. 10051 (July 9, 2026). We do not recommend or help implement any of them.

Get the Big Sale Tax Analysis to see the tax at stake next to the lower-risk paths.

Run your own numbers

Frequently asked questions