Debt Reduction: How to Keep Tax Hits to a Minimum
Borrowers all over the country are scrambling to negotiate a reduction in their loan balances, but many are discovering to their dismay that Uncle Sam is hitting them with huge tax hits on any forgiveness of debt.
Given the present state of the economy, this is a problem that will mushroom considerably over the next year or two as property values continue to decline and the number of loan workouts and debt restructuring skyrockets.
So is there any light at the tunnel for tax-leery owners? As we’ve found here at Financial Management Group, the answer is “maybe,” but it depends on several factors concerning the property.
Take the recent New York case involving Manhattan’s Stuyvesant/Peter Cooper Village. The owner had ran into financial difficulties and offered to turn over the property in a deed-in-lieu of foreclosure. As you’d expect, the lender filed to foreclose. You might have expected the owner to be immediately hit with a huge income tax liability, but one did not arise.
Why?
Because in this case, the property owners avoided a tax liability on the forgiveness of debt since the owners had a cost basis in the property of over $5 billion, which was far greater than the $3 billion owed.
Additionally, the transfer of ownership triggered New York’s transfer tax, assessed at 3.025% of the mortgage. In this case, however, the parties involved realized that their tax load could be reduced if the entity that owns the property were transferred, rather than the property itself. The transfer tax liability, which would have come to $90 million, was reduced to about $60 million and was carried by the lender.