A Taxing Season

Renegotiating debt may have unintended consequences.

As Markets conditions continue to squeeze both landlords and their tenants, renegotiating loan terms can be an effective strategy for property owners to reduce overhead, but beware – the financial implication aren’t as simple as they sound.

Many property owners fail to realize that renegotiated or discharged debt doesn’t just cease to exist. Further, other owners are not aware that they’ll probably need to realize the savings as income. And yes, if you cancel or decrease your debt, you will be liable for taxes in it.

There are three ways property can be surrendered in discharge of debt. Foreclosure is a legally defined procedure for a secured lender to acquire secured property. This is an expensive, time-consuming process for a lender. A deed in lieu is a voluntary transfer of property to the lender in lieu of foreclosure proceedings. A short sale is the sale of property to a third party for an amount less than the debt owed to the lender.

Borrowers may realize two types of income or loss when relinquishing properties. The first is gain or loss on the sale of the property. The second is cancellation of debt income also know as “discharge of indebtedness income.” In either instance borrowers receive either or both of the following tax forms: Form 1099-A, “Acquisition or Abandonment of Secured Property,” issued by a lender when it becomes aware that a property has been abandoned by the borrower or otherwise acquired by the lender, and Form 1099-C, “Cancellation of Debt,” issued when debt is canceled in connecttion with the surrender of property in discharge of debt.

The nature of the debt determines the tax implications. Is the canceled debt recourse or nonrecourse? With recourse debt, the lender has recourse against the borrower for the debt. With nonrecourse debt, the lender may only take property that secures the loan as satisfaction of that loan. Pure nonrecourse loans are very rare today. Occasionally a loan can have both a recourse provision for a limited amount and a nonrecourse provision that permits the lender to retain possession of the secured property.

For recourse debt, the (taxable) gain or loss on the surrender of property is calculated as the difference between the amount of debt owed on the property and the fair market value of that property. In addition, cancellation of debt income realized on the surrender of property in discharge of a recourse debt is calculated as the difference between the fair market value of the property minus the amount of debt owed. This income is taxable.

For discharge of a nonrecourse debt, the gain or loss on the surrender of property is calculated as the difference between the amount of debt owed on the property and the borrower’s basis in that property. This also is taxable. However, the forgiveness of a nonrecorse debt does not result in taxable cancellation of debt income, since the terms of the loan do not give the lender any rights to pursue the owner personally in case of default.

It appears that borrowers with nonrecourse loans are much better off. But that isn’t always the case. There are three exceptions when commercial property owners may exclude the realization of cancellation of debt income following the surrender of property in discharge of a recourse debt.

  1. If the debtor’s debts have been discharged in a Title II bankruptcy proceeding, it may be excluded.
  2. If the debtor is insolvent at the time the debt is discharged. the amount of COD income equal to the amount that a debtor is insolvent may be excluded. the amount of insolvency i measured as the difference between the value of all of the debtor’s assets and all of the debtor’s liabilities.
  3. If the discharge is of “qualified real property business indebtedness,” certain tax attributes of the debtor taxpayer will need to be reduced by the amount of COD income that is excluded. The tax attributes that must be reduced include operating or capital or passive activity losses, tax credits, and depreciable basis in other properties.

To avoid unpleasant surprises,  make sure to assess all of the tax implications before completing the renegotiation of commercial real estate debt. Typically the overall effect is positive, but it’s important to consult your tax advisers for guidance.

Rental property owners, be aware of the IRS requirements.

“The tax entenders package” is set to expire January 1, 2011. If you are owners of rental property; The IRS requiring rental property owners to file an IRS Form 1099 to all contractors with whom they do business if they pay that contractor more than $600 per year. If you already are filing 1099 forms for vendors whose gross income exceeds $600 per year, you can disregard this notice.

If you are small rental property owners are using the property as an investment or as part of  a retirement savings plan. You are not aware of the IRS requirements. Unintentional non-compliance will result in costly penalties, which many owners are ill-equipped to pay. This requirement can be viewed as a trap for the unwary.

Additionally,  hiring a tax professional to ensure compliance with the new rules would be costly and create new expenditures for those already feeling the economic pinch.

If you’re worried you’re missing the step, be sure to talk to your CPA.

An Real Estate insider’s perspective on information technology and customer chanllenges

Buying a home and searching for real estate used to be a relatively simple and traditional relationship between the real estate professional and client.  The realtor traditionally took the lead and introduced properties to clients and “educated” and led new home buyers through a traditional process and right of “initiation” into home ownership. The roles were clearly defined and there was never any question that this is the way things were done.

With the advent of the internet and advances in information technology, customers are now doing more research and legwork on their own before even contacting a real estate professional.  This growing trend has vastly changed the processes that so many real estate professionals had become accustomed to.  In today’s high tech world, clients often find their own listings and properties and only call the realtor as a necessity to facilitate the showing and subsequent escrow and sale.  Many customers bypass the realtor completely and try to deal directly with sellers on their own.

I think the public needs to carefully evaluate what a realtor’s role is in the entire process and the benefit of having the professional representation and knowledge of someone who has been trained and knows what to look for in making certain that the real estate clients right and interests are protected.  Realtors don’t only look for and show listings, they are negotiators, organizers, resources of information and in many cases counselors and “therapists”.  It is amazing what an intimate and intense relationship develops between client and realtor.  A good realtor must be able to know exactly what a client’s objectives are and how to best achieve them.

Anyone can look up and find listings and view the pictures online, however only a real estate professional can guide you through the maze of do’s and don’ts to make sure that you are going down the right path.  Realtors often have the insight and specific knowledge of a neighborhood and its history and specific facts that just are not available online no matter how much research is done.