In today’s real estate market, there remain a large number of commercial properties with debt in excess of the fair market value of the property. Workouts often involve turning over the keys to the property in exchange for the cancellation of the debt plus a general release of all claims by the lender. These transactions, while often necessary, can be a double whammy for the borrower. Not only do they wipe out any equity investment, they may also create taxable gain for the owner/borrower via the cancellation of indebtedness, depending on their tax basis in the investment.
Tax practitioners had often wondered whether the provisions of Section 1031 of the IRS Code, which, under certain conditions, can allow taxpayers to defer the gain associated with the sale of real property, could be used in these types of situations. Until recently, the IRS had provided no guidance on this issue.
This January the IRS issued a Private Letter Ruling on this issue for the first time. While the ruling is not law and is specific to the facts of the situation, it does provide some guidance that gain incurred via the cancellation of non-recourse indebtedness can be deferred via Section 1031.
Please refer to this excellent article on the subject by Mark Fawer and Vincent Guglielmotti of the law firm of Brown Rudnick, which provides much more background and detail on this issue.
ABOUT THE AUTHOR: Andy Brownstein is CFO & General Counsel at GRS Group firstname.lastname@example.org