Commercial Real Estate Tax Bill - NOT!

Commercial Foreclosure – Net Leasing

Never heard of net leasing before?  Not surprising – most people haven’t.  If you are facing a commercial foreclosure and you have any tax deferred gains (i.e. 1031 money) in the property being foreclosed on, chances are you’ll wish you had heard of the net leasing before the foreclosure was done.

In a nutshell, when there is a commercial foreclosure on an underwater property that an owner has tax deferred money in,  the owner will realize three guaranteed things: 1. Loss of equity. 2. Lose of the property. 3. Tax bill.

While a buyer may expect the first two, they don’t expect the third.  Low and behold though, when there is cancellation of debt, it is considered a deemed sale.  A deemed sale of property, especially one with 1031 money, generally means a tax bill.  Buckle up.

There is a solution to this vexing problem though, and it is called net leasing.  While there are millions real estate agents out there pitching their next listing to you or asking you to list your property with them, there are very few who know the ins and outs of net leasing and how to get around the tax bill problem resulting from the commercial foreclosure.

An example of sample situation:

Owner acquired building in 1990 - $5,000,000

By 1999, building appreciated to $11,000,000 – owner refinanced property leveraging 80% non-recourse debt – draws $3,800,000 tax free.

Shortly after cash-out refinance, market plummets – values are down, leases are renegotiated down. By end of 2003, fair market value of building is $5,500,000 and income generated only 60% of debt service. 

Owner in default for over a year and faced foreclosure.  His adjusted basis was $2,000,000. 

If lender foreclosed, amount realized by owner = $11,000,000 which was amount of outstanding non-recourse debt plus accumulated interest and penalties.  Owner faced taxable gain of $9,000,000 – the resulting tax consequence – Fed=$1,350,000, CA=$830,000 = total of $2,180,000.

Solution:

Through a qualified intermediary, owner acquires replacement property of investment grade asset with 20+ year absolute net lease which has self-amortizing, non-recourse debt in place.  The average loan to value is an astounding 87% with an all-in cost of approximately 13-15% including closing costs, legal and qualified intermediary expenses.

Bottom line – if you’re facing foreclosure on an asset that has low basis but is underwater because of market conditions and/or prior cash-out refinancing, there is still a way out.  Talk to a professional today about net leasing.  If your broker doesn’t know about it, that’s not surprising.  Contact us for an evaluation today.  We have ready access to a pool of investment grade product and can get the deal done.

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Greg Royston is a licensed attorney in California as well as a licensed real estate broker. His transactional law practice caters to individuals and small businesses with particular emphasis on business law, tax and real estate matters including leasing, acquisitions, dispositions and commercial loan and lease restructuring.  Before practicing law, Mr. Royston was in public accounting (formerly part of the Big 8, now the Final 4) for eight years offering tax, estate planning and benefits consulting services specifically to high net worth clients and small and medium sized businesses.   For consultation, he can be reached at 310-525-3713 or greg@sbaylaw.com.