For commercial property owners the tax burdens of getting a lender to forgive or modify a mortgage debt may be more onerous that the debt itself but new legislation could help.

“This is a very real issue right now” said Richard M. Goldstein partner chair of the Tax Group and co-chair of the Wealth Transfer Group at law firm Bilzin Sumberg. “Many borrowers are going to their lenders and asking if they would consider modifying their loans by changing the interest rates or lowering the principal balance.

“To the extent that the borrower is successful that’s cancellation of indebtedness and they will have to pay taxes on that income.”

Neil Rollnick partner-in charge of the Miami office of Adorno & Yoss and chair of the law firm’s national Real Estate Department said he is fielding many requests for restructuring that does not involve the writing down of loans. “Many people might prefer to owe the lender than the IRS” he said.

Cancellation of debt or significant modification of the amount owed is usually the result of one of three legal actions: foreclosure deed in lieu or short sale said Dennis Fitzpatrick a principal with accounting and consulting firm Kaufman Rossin.

“Income from cancellation of debt is considered taxable by the IRS” he said “yet many real estate owners are unaware of this and could find themselves in hot water when they file their year-end returns.”

An exception would be a nonrecourse loan Mr. Fitzpatrick said in which the borrower can’t be held personally responsible for debt on a property “but we haven’t seen those in a very long time – perhaps since the savings & loan debacle.”

The tax code allows for some other exceptions said Michael B. Axman a partner in the Business Law Department of Adorno & Yoss.

“The most common is Title 11 bankruptcy” he said. “Discharge of debt in that context is not gross income. There’s also an exception for insolvency when the discharge doesn’t get you to a situation where you’re solvent – but that’s difficult to prove because if the project can meet other payments it’s not considered insolvent.

“There are complicated rules on this. At the individual level you have to have depreciable property to allocate this deduction against and the project has to be under water.

“If for example it’s a condo development condo units are not depreciable property but inventory so you can’t use it as depreciable property.”

As part of the American Recovery & Reinvestment Act of 2009 Mr. Goldstein said the federal government has made provisions that “allow a taxpayer to elect to defer the recognition of income to 2014 and to spread the payment of the actual liability over the following five years.”

For anyone who qualifies Mr. Axman said “the end result is a 10-year interest-free deferral of the tax.”

In general Mr. Fitzpatrick said “banks don’t want to take property back. It doesn’t look good on their balance sheets.

“People who have distressed property really need to start working with their banks. If they can do some sort of workout or short sale it’s to their advantage to do so.”

Mike Stein principal of Pensam Capital a bridge lender said he expects “50% of our business in 2010 will be done in the area of debt purchase and restructures or bridge loans made to folks either buying debt or restructuring their own debt.”

Many loan requests in the past 90 to 120 days he said have been for new capital to come in and take out existing bank financing.

“We are involved in several transactions where we as a private lender are coming in” Mr. Stein said “purchasing a loan or a note from a bank and then modifying it with the same borrower and recasting it either as straight debt or as debt with equity participation.”

To the new lender or new capital coming in he said “the structuring of the deal is of utmost importance. Otherwise it could trigger some significant tax implications. “Sometimes the borrower would be better off giving the property back to the lender than creating a significant taxable event for themselves based on forgiveness of debt.”

“”miami-today120x80.jpgmiami today.png”