Presenting a live 110 ‐ minute webinar with interactive Q&A Tax Issues in Real Estate Loan Tax Issues in Real Estate Loan Workouts, Foreclosures and Short Sales Avoiding Unintended Tax Consequences With Distressed Property WEDNES DAY, NOVEMBER 9, 2011 1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific T d Today’s faculty features: ’ f l f Edward J. Hannon, Partner, Freeborn & Peters, Chicago tephen M. Breitstone, Partner, Meltzer Lippe Goldstein & Breitstone, Mineola, N.Y S . Attendees seeking CPE credit must listen to the audio over the telephone. Please refer to the instructions emailed to registrants for dial-in information. Attendees can Please refer to the instructions emailed to registrants for dial in information. Attendees can still view the presentation slides online. If you have any questions, please contact Customer Service at 1-800-926-7926 ext. 10 .
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Tax I ssues in Real Estate Loan W orkouts, Foreclosures and Short Sales Avoiding Unintended Tax Consequences With Distressed Property Avoiding Unintended Tax Consequences With Distressed Property Stephen M. Breitstone Edward J. Hannon Meltzer, Lippe, Goldstein & , pp , Freeborn & Peters LLP Breitstone, LLP, Mineola Chicago (516) 747 ‐ 0300, x241 (312) 360 ‐ 6754 sbreitstone@meltzerlippe.com ehannon@freebornpeters.com November 9, 2011 • 11931604 5
Tax Consequences Of Loan Workouts k 1 1. Transfer of the property in connection with a Transfer of the property in connection with a foreclosure or deed in lieu of foreclosure is a sale or exchange of the property for income sale or exchange of the property for income tax purposes. 2 2. A modification of the loan, including a write ‐ A modification of the loan including a write down of the amount owed, can create cancellation of indebtedness income cancellation of indebtedness income. 6
Example 1 Example 1 Amber LLC is owned by Max Vincent and Sam Amber, LLC is owned by Max Vincent and Sam Deen. Amber owns a warehouse that is subject to $10 3 million of debt The current fair market to $10.3 million of debt. The current fair market value of the property is $9.4 million. Amber’s tax basis in the property is $7 8 million and Amber basis in the property is $7.8 million and Amber has accumulated depreciation deductions of $4 7 million $4.7 million. 7
Example ‐ Loan Modification Example Loan Modification • The lender agrees to reduce the debt to $9.4 million. • Because the debt has been reduced by $900,000, Amber recognizes cancellation of , , g indebtedness of $900,000. 8
Example 2 Example 2 • Same facts as Example 1 but instead of Same facts as Example 1, but instead of agreeing to modify the loan, the lender forecloses forecloses. 9
Example ‐ Foreclosure Example Foreclosure • Tax consequences of the foreclosure will Tax consequences of the foreclosure will depend on whether the loan is recourse or non ‐ recourse for federal tax purposes non recourse for federal tax purposes. 10
If Debt Is Non ‐ Recourse: If Debt Is Non Recourse: Amount Realized Amount Realized $10 3 million $10.3 million Tax Basis $7.8 million Taxable Gain bl G i $ $2.5 million ll 11
If Debt Is Recourse: If Debt Is Recourse: $9.4 million $ Amount Realize Amount Realize $7.8 million Tax Basis $1 6 million $1.6 million Taxable Gain Taxable Gain Cancellation of Indebtedness Income: $10.3 million $10 3 illi A Amount of Loan t f L Payment $9.4 million $ $.9 million Amount of CODI 12
Additional Issues To Consider In A Foreclosure Or Deed In Lieu Of Foreclosure Deed In Lieu Of Foreclosure 13
Revenue Ruling 90 ‐ 16 Revenue Ruling 90 16 • IRS addresses tax consequences of deed in lieu of foreclosure transactions (a consensual lieu of foreclosure transactions (a consensual workout in which the property is transferred to the lender) to the lender). • In this Revenue Ruling, the IRS states that, if instead of transferring the property back to instead of transferring the property back to the lender pursuant to a settlement agreement, the property had been transferred g , p p y to the lender in a foreclosure, then the tax result would have been the same. 14
Open Issues In Rev. Rul. 90 ‐ 16 Open Issues In Rev. Rul. 90 16 • How does a “covenant not to sue” from the How does a covenant not to sue from the lender change the analysis under Rev. Rul. 90 ‐ 16? 16? 15
Short Sales Short Sales • Same facts as Example 2 except that instead Same facts as Example 2, except that instead of transferring the property back to the lender Amber sells the property to a third lender, Amber sells the property to a third party for $9.4 million. 16
Short Sales Short Sales • If the loan is a recourse loan Amber will If the loan is a recourse loan, Amber will recognize both gain on the sale and cancellation of indebtedness income cancellation of indebtedness income. • If the loan is a non ‐ recourse loan, Amber will recognize gain based on an amount realized of recognize gain based on an amount realized of $10.3 million (the amount of the non ‐ recourse debt) debt). 17
Determining Whether Debt Is R Recourse Or Non ‐ Recourse O N R For Purpose Of Code Section 1001 18
Under subchapter K of the Code, Section 752 sets forth specific rules for determining whether sets forth specific rules for determining whether indebtedness is recourse or non ‐ recourse for purposes of calculating a partner’s tax basis in purposes of calculating a partner s tax basis in its partnership interest. • Under Treas. Reg. § 1.752 – 1(a)(2), if no partner bears the economic risk of loss, the debt is treated as non ‐ recourse debt for the purposes of these partnership tax recourse debt for the purposes of these partnership tax rules. • Under Treas. Reg. §1.752 – 1(a)(1), a debt is recourse for g § ( )( ), purposes of these partnership tax rules to the extent that any partner bears the economic risk of loss for the liability liability. 19
The rules of Code Section 752 focus on the The rules of Code Section 752 focus on the relative “economic risks” among the partners. • This “economic risk” concept is not relevant for purposes Thi “ i i k” t i t l t f of whether a borrower has gain from a foreclosure or cancellation of indebtedness income. • Instead, the guidance under Code Section 1001 must be examined. 20
Guidance Under Code Section 1001 Guidance Under Code Section 1001 • No bright ‐ line rule No bright line rule. • Guidance given in Examples 6 and 7 of Treas. Reg 1 1001 2 (c) Reg. 1.1001 ‐ 2 (c). 21
Treas. Reg. 1.1001 ‐ 2 Treas. Reg. 1.1001 2 • Non ‐ recourse debt — creditors remedies upon Non recourse debt creditors remedies upon default are limited specified collateral. • Recourse debt • Recourse debt — loan documents do not limit loan documents do not limit lender’s rights to specific collateral. 22
Open Issue: Is determination of recourse or non ‐ recourse based solely on loan documents? 23
Investors Investors Manager Manager Real Estate Fund, LLC Lender Loan SPE Shopping Center 24
Cancellation Of Indebtedness Income d b d • Code Section 108 Code Section 108 – Bankruptcy – Insolvency Insolvency – Qualified Real Property Business Indebtedness – Purchase Price Adjustment P h P i Adj t t 25
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