Tax Implications of Loan Forgiveness

There is an article in the latest issue of the NAR’s Commnews Roundup discussing the downside of loan forgiveness as far as taxes are concerned. We weren’t able to locate the article online, so we’ll give you a synopsis:

• Provisions of the economic stimulus legislation permit CRE owners to postpone tax liability on forgiven mortgage debt until 2014.
• For a typical owner, electing to postpone until 2014, and then paying the tax liability over 5 years works best, though for an operating partner, this might not work:
  • If a property owner elects to postpone on the forgiveness tax and then files BK in 2 years, BK doesn’t wipe out the tax on the loan forgiveness
  • If the payment wasn’t put off, then the taxes owed would be deferred, reduced or eliminated. Insolvency also doesn’t eliminate the deferred tax liability
• Other provisions that defer taxes also mean that basis of the property is lowered by the amount of the forgiven debt – so in a few years, the lower basis will trigger a higher capital gains, even though the tax attributable to the debt has been paid.
• Selling a property triggers immediate obligation to pay all of the taxes on the deferred debt
• Tax liability is triggered if a partner sells his or her interest - translation: know who you are in bed with.
• The election of the tax postponement has to be made at the partnership level so all partners must use same strategy

Long story short is that the tax deferral on forgiven debt also has a bite. The article quoted Jeff Dowd and John Woodbury, principals at Chicago’s Reznick Group.

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