Minimum Gain and Safe Harbor

On this webpage I discuss the minimum gain and the minimum gain charge back in tax equity that is particularly painful.  I try to first define what is meant by the term minimum capital gain — is it a capital gain; where does that capital gain come from; and why does non-recourse debt at the LLC level create a capital gain for taxes. The principal question in economic analysis is how does the minimum gain affect much and in particular, does it affect the IRR.  Another basic question is, what gain are we even talking about (it sounds like some sort of gain on sale); is it income; is it cash; what is it.  The next question is how does the minimum gain and the famous minimum gain charge back affect the inside basis and the outside basis.  Some basic points about the minimum gain is that it arises when there is non-recourse debt at the partnership SPV. It does not occur when there is back leverage.

Definition of Minimum Gain

I have trouble finding the definition of the minimum gain.  One article stated: “Minimum gain is the amount by which the non-recourse debt exceeds the Section 704(b) basis in the property secured by the debt.” Let’s translate this.   This implies that you should first compute the 704 basis in property which I assume is the opening balance plus income minus debt.

The Regulations create a concept called partnership minimum gain. Minimum gain is the amount by which the non-recourse debt exceeds the Section 704(b) basis (is this the gross asset balance or the equity balance) in the property secured by the debt. The concept is that a non-recourse deduction can be allocated to a partner to cause its capital account to be negative, even without a partner obligation to restore that negative capital account.

This is because the negative capital account will later receive an allocation of income whenever there is a decrease in the minimum gain.

A and B each contribute $100 to a 50-50 partnership and have no obligation to restore negative capital accounts. The partnership borrows $800 from an unrelated lender on a nonrecourse basis using an interest-only loan and buys Building for $1,000. The partnership depreciates Building by $100 a year.

After the third year, the partnership has depreciated the initial $1,000 of section 704(b) basis in Building to $700. At the beginning of year 3, A and B have each received depreciation deductions that caused their section 704(b) capital accounts to be zero.

Allocating the year 3 depreciation equally to A and B would cause their capital accounts to be negative by $50 each.


Although the general rule is that A and B are not allowed to have negative capital accounts absent a DRO, there is an exception in this case because the deduction is a nonrecourse deduction that creates minimum gain ($800 nonrecourse debt less $700 book basis in Building).

An allocation of the $50 deduction to each of A and B creates an allowable $50 deficit in each partner’s capital account because that deficit is supported by $50 each of minimum gain that the partnership agreement provides the partnership will charge back if there is a later reduction in that minimum gain.

For example, if the partnership disposes of Building the next year for an amount equal to the $800 nonrecourse debt, the entire minimum gain would be triggered (there is no longer any nonrecourse debt to support the minimum gain), and A and B would each be required to report $50 of taxable income.

The partnership has sufficient income to allocate because it has $100 of section 704(b) book income from the sale of Building

This is referred to as partnership minimum gain charge-back.

Substantial economic effect. The question is whether a tax equity investor is a partner or is a “bare purchaser of tax benefits”

Winston and Strawn: Proceeds in liquidation must be distributed according to the positive capital account balances of the partners; and partners with deficit balances in their capital accounts upon liquidation are unconditionally required to restore such deficit balance to the partnership.


A contributes Building with $100 gross FMV, subject to $30 of debt. In year 1 the partnership allocates $10 of section 704(b) book income to A and distributes $4 of cash to A. A’s ending capital account is $76, which is the asset basis of 100 less the debt (note that for the more important outside basis, the debt is not reduced).












IRS Safe Harbor Requirements

Purchase rights must be at FMV when exercised and there is no purchase right during the first 5 years. Sale rights – neither the SPV nor the tax investor nor the developer/sponsor can have a contract to buy or sell their portions in the future.

Throughout the existence of the partnership SPV, the developer must have at least 1% interest in each material item of partnership income, gain, loss, deduction and credit.