IRS Reverses Position On "Bad Boy" Guarantees

Earlier this year, the IRS issued Chief Counsel Advice 201606027 (February 5, 2016) concluding that, for purposes of the basis and at-risk limitations, an LLC member's guarantee of entity-level nonrecourse debt conditioned upon the occurrence of one or more "bad boy" carve-outs caused such debt to be classified as recourse debt with respect to the guarantor. Consequently, the LLC debt would be allocated to the guaranteeing member under the Section 752 debt allocation regulations and such debt would no longer meet the definition of "qualified nonrecourse financing" under Section 465(b)(6)(B). As you might expect, this CCA was not well received by the real estate industry given the prevalence of bad boy guarantees in lending transactions.