Tax consequences of solution transactions - address by Stephen S. Ziegler of Ziegler, Sagal and Winters P.C. law firm

Real Estate Weekly, June 3, 1992 by Stephen S. Ziegler

This is the second in a series of four articles summarizing the federal, New York State and New York City tax consequences of real estate foreclosures, bankruptcies and workouts. The articles will serve as text for a seminar on the tax consequences of these transactions to be co-sponsored by the law firm of Ziegler, Sagal, & Winters and Real Estate Weekly on June 25 at the Grand Hyatt Hotel on June 25 at the Grand Hyatt Hotel from 8:30 a.m. to 11:00 a.m.

As explained in the first article, when a mortgage exceeds the value of the property, and the owner is unable to make mortgage payments, there are two basic options. The owner can either attempt to reach an agreement with the lender to modify the mortgage, or surrender the property.

This article explains that even though the owner of the property has suffered an economic loss from his investment, he may nevertheless incur income taxes in regard to the property.

When property is transferred in full settlement of a nonrecourse mortgage, the owner will be considered to have sold the property to the creditor for the amount owed on the mortgage. Thus, if the mortgage exceeded the owner's adjusted tax basis for the property (the cost of the property plus improvements, less depreciation deductions claimed), the owner would recognize gain from the sale of the property. If the property were rental property, the gain would be characterized as the capital gain.

For instance, if you had a non-recourse mortgage of $1.25 million on an apartment building with a fair market value of $1 million and an adjusted tax basis of $750,000, and then surrendered the property in full settlement of the mortgage, you would realize a taxable gain of $500,000.

Alternatively, if the adjusted tax basis of the property exceeded the mortgage, a loss would result. If the property is rental property, the loss will be characterized as an ordinary loss.