Minimum Gain Charge Back

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In partnership taxation, whenever a partnership takes out a nonrecourse loan for an assets subject to depreciation, there is a risk of tax evasion, as the partners may take the depreciation deductions while defaulting on their loan; in effect, getting the benefit of a depreciable asset for which they did not pay, and on which they intend the creditor to foreclose. Therefore, the IRS in its infinite wisdom, in acted a rule known as the Minimum Gain Charge Back rule. This rule requires that the depreciation deductions be "charged back" to the taxpayer as a gain, causing the taxpayer to pay taxes he previously escaped through the use of the depreciation deduction. This is effectuated by tracking the amount of "minimum gain." Minimum gain is essentially, what the partnership would make if they sold the asset for the amount of the nonrecourse loan. This fictional sale of the asset will result in a gain to the partnership because the depreciation deductions will have lowered the adjusted basis of the asset below the amount of the outstanding liability. Once this gain is calculated it is tracked from year to year. Every year the gain increases (as it will if more depreciation deductions are taken) there will be no tax consequences. However, if, in a given year, the amount of minimum gain decreases or is stagnant, the charge back rule will be triggered. This rule requires the partnership to charge each partner (via the K-1) the total amount of depreciation deductions taken in the past as income in the current year. This way, the partners are not able to ride a nonrecourse asset's depreciation deductions without realizing a gain. While this system does allow the partner to take advantage of the time-value of the depreciation deduction, it closes what would otherwise be a gigantic tax loop hole.