private letter ruling (plr) 201302009

Like-Kind Exchanges and

Deeds-in-Lieu of Foreclosure

Presented by:

Andy GelsonVice President & Assistant General CounselRockland Trust Company288 Union StreetRockland, MA 02370781-982-6738

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IRS Private Letter Ruling (PLR) 201302009 released January 11, 2013

This ruling shows how to do a like-kind exchange when giving the lender a deed in lieu (DIL) of foreclosure on the relinquished property.

The real estate at issue in the ruling had:

•Low tax basis

•Non-recourse mortgage debt

•The FMV of the real estate was significantly less than the debt.

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http://www.irs.gov/pub/irs-wd/1302009.pdf

Private Letter Ruling (PLR) 201302009 released January 11, 2013

• A simple DIL to the lender or a foreclosure would create a significant tax liability.

• The lender agreed to take the property subject to the outstanding mortgage.

• The question is how to structure the transfer so that the taxpayer could also do a like-kind exchange.

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In a 1031 exchange exchange, to fully defer the gain, a taxpayer must:

• Acquire replacement property valued equal to or greater than the relinquished property, and

• The QI must invest all of the cash proceeds from the relinquished property into the replacement property.

Comment: It’s a common misconception that the taxpayer only needs to reinvest their equity in like-kind replacement property. In a DIL there is no equity to reinvest. This illustrates the point that any reduction in value of replacement property is a “cashing out” that will produce either mortgage boot or cash boot!

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However, In a DIL situation, the taxpayer needs to acquire replacement property with a value equal to or greater than the non-recourse debt to fully defer the gain. The taxpayer was concerned that the transfer to the QI would only be a transfer equal to the fair market value of the property, rather than the amount of the debt. In any sale or exchange, the sale price (“amount realized”) is the sum of any cash received, the fair market value of any property received, and the amount of any debt assumed or to which the transferred property is subject. IRC §1001.

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• When the debt is non-recourse and the fair market value of the property is lower than the amount of the mortgage debt, the full principal amount of the debt is included in the amount realized. Tufts v. Commissioner, 461 U.S. 300 (1983).

• Following the rationale of Tufts, the IRS said in the ruling that the transfer to the QI would be for the amount of the mortgage debt.

• Therefore, the assignment of rights under the contract to transfer the property by DIL to the lender would be treated as a transfer of the property subject to the full amount of non-recourse debt.

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• It would be more difficult to accomplish an exchange in a foreclosure or trustee’s sale, because there is no contract to assign to the QI, meaning the QI would need to acquire title prior to the foreclosure sale in order to acquire and transfer the relinquished property.

• If a foreclosure is necessary to remove junior liens, a DIL to the lender, followed by a post-DIL foreclosure would offer more flexibility to structure an exchange.

• The DIL agreement’s sections relating to the treatment of the debt at the time of transfer (whether the transfer is subject to the debt or in cancellation of the debt) should be carefully reviewed by counsel.

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• If the debt is recourse debt, different rules apply!

• The transfer of property to the QI would be limited to the fair market value of property.

• Any relief of liabilities exceeding the value of the property would result in cancellation of indebtedness income (“COD income”) under IRC §61(a)(12).

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• COD income is not eligible for deferral under §1031 because it is not gain from the sale or exchange of property.

• However, COD income may be eligible for exclusion under §108 if the taxpayer is bankrupt or insolvent, or the taxpayer elects to treat the debt as qualified real property business indebtedness (QRPBI).

• If the taxpayer elects COD exclusion as QRPBI, the basis of the property will be reduced, and the gain taxed as ordinary income. Reduced basis and character of gain may be relevant in deciding whether to do a §1031 exchange in the year of sale.

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Replacement Property for DIL Property:

• In DIL situations, we’ve observed that triple net property, leased to a tenant with an investment grade credit rating is often used as replacement property.

•Because of the higher loan-to-value ratio these properties can support, this type of property is ideal, and the debt on the property is typically non-recourse.

•It is also easier to “exchange out” of triple net leased property when a core property later becomes available.

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Andy GelsonVice President & Assistant General CounselRockland Trust Company288 Union StreetRockland, MA 02370781-982-6738 [email protected]

If you have any questions relative to this strategy or any other like-kind exchange questions, please contact:

About Compass ExchangeCompass Exchange Advisors LLC (Compass) is a Qualified Intermediary (QI) focused on providing its clients with guidance, strategies, and solutions for all their Section 1031 like-kind exchange needs. Our clients own property and wish to sell property, buy replacement property, and defer paying taxes.

About Rockland TrustRockland Trust Company is a full-service commercial bank headquartered in Massachusetts, with $5.7 billion in assets. Ranked "Highest Customer Satisfaction with Retail Banking in the New England Region" in 2012 by J.D. Power and Associates, Rockland Trust's network consists of 77 retail branches, 10 commercial lending centers, four investment management and one residential lending center located throughout Eastern Massachusetts and in Rhode Island - including nine Central Bank branches, a division of Rockland Trust as of November 10, 2012. To find out why Rockland Trust is the bank "Where Each Relationship Matters®", please visit www.RocklandTrust.com. Member FDIC. Equal Housing Lender.

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private letter ruling (plr) 201302009

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