By Dennis J. Fitzpatrick
Tax principal
Kaufman, Rossin & Co.
Lowering Debt Can Be Taxing o r b an
Brokers should know implications when clients renegotiate or discharge loans
In today’s economy, renegotiating and reworking commercial-prop- erty financing is becoming more of
a necessity. Property owners who have
renegotiated loans may not know they
do not simply receive a free pass from
a tax perspective, however. Commercial mortgage brokers should be aware
of the possible effects these renegotiations can have on their clients’ finances.
Renegotiating or discharging debt
can be a great short-term strategy. The
savings, however, may later need to be
realized as income at tax time. A cancellation or reduction of debt may create a tax liability. The tax implications
of renegotiating and discharging debt
are nuanced and complex. These tax
rules are summarized below. Commercial mortgage brokers should advise
clients to seek professional tax guidance before making final decisions.
There are three general ways bor-
rowers can surrender a property to dis-
charge debt:
1. Foreclosure: This is a legal proce-
dure for a secured lender to acquire
the property.
2. Deed in lieu of foreclosure: This is a
voluntary transfer of property to the
lender in lieu of foreclosure.
3. Short sale: This is the sale of prop-
erty to a third party for less than the
debt owed to the lender.
The borrower may realize two types
of income or loss when relinquishing
a property in cancellation of debt. The
first is gain or loss on the sale of the
property. The second is cancellation of
debt income, also known as discharge
of indebtedness income. In either instance, the borrower will receive either
or both of the following tax forms:
• Form 1099-A, “Acquisition or Aban-
donment of Secured Property”
• Form 1099-C, “Cancellation of Debt”
abandonment. Form 1099-C will state
the amount of debt canceled.
Save the Date 38 Scotsman Guide Commercial Edition | scotsmanguide.com | April 2011
“If your clients
are considering
renegotiating
their loans,
you should be sure
they are aware of
the potential tax
ramifications.”
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• Hotel Financing: Where are the Opportunities?
• Multifamily Finance-Fannie Mae, Freddie Mac & HUD
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It works this way:
• A borrower will recognize taxable
gain or loss on the surrender of property in discharge of a recourse debt.
The gain or loss is calculated as the
difference between the amount of
the property’s fair market value and
the borrower’s stake in the property.
In addition, cancellation of debt income is realized to the extent that
the amount of debt exceeds the
property’s fair market value.
• Taxable gain or loss is also recognized on the surrender of property
in discharge of a nonrecourse debt.
The gain or loss is calculated as the
difference between the amount of
debt owed on the property and the
borrower’s stake in that property.
The cancellation of nonrecourse
debt does not result in cancellation
of debt income, however.
• The character of gain or loss in either
case depends on the use of the prop-
erty before the discharge of debt.
Property used in a business (e.g.,
rental property) may generate capi-
tal gains and ordinary losses. Prop-
erty held for sale (e.g., inventory of
a developer) will generate ordinary
income or loss. Cancellation of debt
income is always ordinary and there
cannot be a cancellation of debt loss.
Further, cancellation of debt income
can arise when debt is just reduced
but not canceled.
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Disclaimer: This article is not intended to be
used for the purpose of avoiding tax penalties,
and it cannot be used for that purpose. Further,
this article is a general description of current
tax law and is not presented as a tax opinion
on any general or specific tax issue or situation. This article may not be used to promote
or market any transactions stated in the article.
Readers are advised to seek advice from their
own tax advisers if they have questions.
Dennis J. Fitzpatrick, J.D., is a tax principal
with Kaufman, Rossin & Co., one of the top
accounting firms in the Southeast. Reach
him at dfitzpatrick@kaufmanrossin.com.
