Webinar Transcript (9/4/2025): “Tax Issues with Distressed Real Estate”
Host: Jonathan I. Shenkman, President & Chief Investment Officer of ParkBridge Wealth Management (Contact: jonathan@parkbridgewealth.com)
Presenter: Matthew E. Rappaport, Esq. LL.M. Vice Managing Partner, Falcon Rappaport & Berkman LLP (Contact: mer@frblaw.com)
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Jonathan Shenkman: Good morning, and welcome to the Park Bridge Wealth Management Fall Webinar Series. This program is entitled, Tax Issues with Distressed Real Estate. As always, my name is Jonathan Shankman. I'm the President and Chief Investment Officer of Park Bridge Wealth Management. In that role, I serve in a fiduciary capacity to help my clients achieve their financial objectives.
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Jonathan Shenkman: The goal of my programs is to bring professionals together to help them better serve their clients. This is done by educating attendees on the latest topics in wealth planning, and by encouraging collaboration between a client's attorney, CPA, and financial advisor where appropriate.
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Jonathan Shenkman: My practice focuses on working with high net worth families, businesses, and non-for-profits. I manage individual investment portfolios, trust accounts, corporate retirement plans, and endowments to help my clients achieve their financial goals.
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Jonathan Shenkman: In addition to the 20 or so events I run every year, I also do a fair amount of writing on the topics of investing and financial planning. And you created my work in a variety of periodicals, including Barron, CNBC, Forbes, Keplinger, The Wall Street Journal, and Trust and Estates Magazine, to name just a few.
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Jonathan Shenkman: You can see all my work on my website at parkbridgewealth.com forward slash articles, or by following me on social media at Jonathan on Money. Additionally, you can check my weekly podcast, which is also called Jonathan on Money, and you can listen to that on Apple, Spotify, or wherever you get your podcasts.
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Jonathan Shenkman: Today, we're privileged to hear from Matthew Rappaport, who's the Vice Managing Partner at Falcon Rappaport & Berkman, based in Long Island, New York. Matt shares his firm's private client groups. His concentration is, in taxation as it relates to real estate, closely held businesses, private equity funds, family offices, and trusts and estates.
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Jonathan Shenkman: He advises clients regarding tax planning, structuring, and compliance for commercial real estate projects, all stages of the business life cycle, generational wealth transfer, family business succession, and executive compensation.
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Jonathan Shenkman: Matt is known for his work on complex deals involving advanced tax considerations such as Section 1031 exchanges, the Qualified Opportunity Zone program, freeze partnerships, private equities, mergers and acquisitions, and qualified small business stock.
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Jonathan Shenkman: Today, Matt will be speaking about tax issues with distressed real estate, and with that introduction, I'll now turn the program over to Matt.
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Matthew E. Rappaport: Yoni, I very much appreciate that, thank you, the intro makes me sound cooler than I am, but some of you folks have either… some of you folks know me based looking at the attendee list. Some of you folks are smarter than me, also, all you folks are smarter than me, looking at the attendee list out of people I know. I'll take that as a sample. And then…
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Matthew E. Rappaport: You know, from my point of view, I think it's always a privilege to appear here.
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Matthew E. Rappaport: This has 58 slides, and we have 30 minutes, or just a shade shy of 30 minutes, so I will have to turbo mode this, but anything that's especially esoteric, I think I'm just gonna skip over.
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Matthew E. Rappaport: Yeah, standard disclaimer, don't sue me. But I think where we begin
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Matthew E. Rappaport: is we begin with why the topic is relevant. The reason I wanted to dive into this is because I'm getting more and more inquiries now as the market
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Matthew E. Rappaport: Originally, I thought the market was simply sliding its way downward in the…
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Matthew E. Rappaport: U.S. real estate environment. That's not really true. From what I read and from what I hear, I think the market is now bifurcating.
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Matthew E. Rappaport: From what I see anecdotally, and then in terms of the information that I've digested from economists and real estate publications and the like, is that there are certain sectors where real estate is rebounding.
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Matthew E. Rappaport: in my home jurisdiction of New York, where a lot of you are tuning in from, but not all of you, I mean.
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Matthew E. Rappaport: from what Yoni tells me, he's getting folks who are tuning in from all over the country, so there are certain pockets of the country where certain sectors are suffering. To my understanding, for instance, I don't think San Francisco office has bounced back. Bay Area stuff. I don't think it's bounced back. On the other hand.
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Matthew E. Rappaport: New York City office is at occupancy rates that are basically right in line with just before the pandemic started.
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Matthew E. Rappaport: So, that's just an example of the bifurcating market, but you do have inflation that is still occurring.
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Matthew E. Rappaport: As we are recording this presentation live, it's Labor Day week of 2025.
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Matthew E. Rappaport: There is some debate as to whether or not the tariffs that have been implemented and…
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Matthew E. Rappaport: you know, negotiated and hemmed and hawed with, you know, across various different countries have actually hit in terms of inflation and pricing yet. Maybe they haven't, maybe they haven't.
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Matthew E. Rappaport: The interest rates, are they gonna continue to rise? You know, based on Jerome Powell's recent comments, maybe yes, maybe no.
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Matthew E. Rappaport: The vacancy rates, they're growing in some places, they're not growing in other places. And then in terms of rental growth, I think it's slowing almost everywhere. The uniqueness of, I think, New York and Southern California and Illinois is that you have an artificially low supply of certain classes of real estate, namely residential.
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Matthew E. Rappaport: And supply and demand is just making rental growth continue regardless of overall economic conditions.
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Matthew E. Rappaport: But the thing is, if you look across the country generally, and there are lots of New York-based investors who are invested everywhere in the United States, not just in local sorts of markets where you have tri-state, and the suburbs, and all sorts of other jurisdictions that feed off of New York City.
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Matthew E. Rappaport: they are seeing some real slowdowns. I think in terms of multifamily, the places that are seeing the biggest slowdowns are probably the Sun Belt.
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Matthew E. Rappaport: and the Southeast, I think based on the idea that they actually develop things out there, unlike they do in our metro area, that has made supply and demand be in much more equilibrium, and therefore it's more sensitive to
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Matthew E. Rappaport: the fluctuations that are occurring on the demand side. So what happens, right, in the event that you have a…
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Matthew E. Rappaport: high leverage, with a high loan-to-value ratio, you have high leverage real estate, and then all of a sudden, you know.
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Matthew E. Rappaport: The real estate sees a higher level of vacancy, or the real estate doesn't hit the assumptions that you brought into your pro forma when you went in and applied for the financing that you got, or you went ahead and you solicited investors on the equity level.
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Matthew E. Rappaport: Well, it's, you know, the options that you have are going to depend on a number of different factors, including how cooperative is the lender going to be with you on working out what goes on with the existing loan. Is the debt recourse or non-recourse? That's going to be a big distinction, because tax consequences of any sort of measures that you take
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Matthew E. Rappaport: are going to depend on whether the debt is recourse or non-recourse. There's an important distinction there. For federal income tax purposes, recourse debt largely means, not 100%, but it largely means that you have a full, unconditional personal guarantee
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Matthew E. Rappaport: By a flesh-and-blood human being, or by a business with legitimate resources behind it.
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Matthew E. Rappaport: Every other type of debt is non-recourse. People often ask me, what about bad act carve-outs? What about construction guarantees? They're considered non-recourse for federal income tax purposes. Recourse really means you have a full and unconditional personal guarantee behind it. Otherwise, the debt's generally considered non-recourse. There are nuanced exceptions to that, but we don't have enough time to discuss them today.
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Matthew E. Rappaport: What about solvency? Do you have the opportunity to take an exception, especially for recourse debt and Section 108, cancellation of indebtedness income?
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Matthew E. Rappaport: Do you have the opportunity to claim an insolvency or bankruptcy exception? What about exclusions? Even when you are solvent and when there is no bankruptcy, there are exclusions that you can claim in the real estate world that are pretty cool.
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Matthew E. Rappaport: And who's the taxpayer that's looking to get advantages in the way that debt restructuring is going to be treated? Do you have a business entity? Do you have an individual? And if you have a business entity, what type of taxpayer is it? We're gonna go through this as we talk about what the options are, right?
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Matthew E. Rappaport: And you'll see that those factors play a big, big role.
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Matthew E. Rappaport: So, let's talk about what can actually happen from a…
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Matthew E. Rappaport: Non-tax sort of debt negotiation point of view, right?
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Matthew E. Rappaport: Well, one thing that can happen is, the owner can retain the property. That's a big umbrella of options that you have at the top here. You reduce the principal on the indebtedness.
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Matthew E. Rappaport: Sometimes, the lender is simply willing to play ball here, because they can go ahead and get the income from the interest generated by the reduced principal, and the lender would rather have that
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Matthew E. Rappaport: Then deal with the foreclosure process, or otherwise make, alternative Restructurings to the existing debt.
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Matthew E. Rappaport: You could settle the debt. You could turn around and you could say, I'll pay off the debt, but I'll pay it off at 77 cents on the dollar, something like that. That's a debt settlement.
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Matthew E. Rappaport: A tap workout is basically, as we describe it here.
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Matthew E. Rappaport: A way for the lender to modify the terms of the debt that doesn't really involve principal reduction, and that'll be something like…
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Matthew E. Rappaport: Kicking the can down the road.
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Matthew E. Rappaport: We might extend the maturity date. They might modify the terms of the interest, but leave the principal in place. They might add a personal guarantee, where a personal guarantee did not previously exist.
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Matthew E. Rappaport: They might change the terms of the collateral, etc. That's a workout, really. It's a method by which the lender decides that they're going to delay on taking action in the way of foreclosure.
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Matthew E. Rappaport: But the lender also takes, basically, a pound of flesh.
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Matthew E. Rappaport: In the form of modifications. On the other hand, the other umbrella is that the owner doesn't retain the property.
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Matthew E. Rappaport: The owner could turn around and say, hey, listen, I'll put it up for sale, I'll agree that we'll go ahead and we'll get the highest dollar value we possibly can, and you will get as much of your debt paid off as we can manage, and then that'll mean that if I walk away with a goose egg on equity, so be it. But let me go ahead and spearhead the sale process myself.
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Matthew E. Rappaport: You know, okay, deed and lieu. Deed in lieu is basically handing the keys back to the lender, and turning around and saying, hey, listen, take the property back, just, like, don't bother with foreclosure, I just want to make sure that
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Matthew E. Rappaport: I don't have any sort of personal repercussions for it. That's a deed in lieu. Then you have foreclosure. Foreclosure is the official process, whether a judicial or non-traditional foreclosure, depending on the jurisdiction, where the lender turns around and has the hostile process
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Matthew E. Rappaport: Of foreclosing on the property, and then turns around and sells it for the highest possible dollar amount to the highest bidder.
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Matthew E. Rappaport: Then you have receivership. Receivership is not common in distressed. It's really not common.
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Matthew E. Rappaport: Because it doesn't mean that the property is financially distressed. Most commonly.
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Matthew E. Rappaport: The receivership option is put into place when there is a dispute between the owners.
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Matthew E. Rappaport: Or, the property is financially healthy, but the owner has done something that the bank really doesn't like, bad act carve-outs and things like that. So the property is functioning, it's financially profitable, the lender can get paid.
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Matthew E. Rappaport: But, you know, this is about, really, disputes over financially healthy property that I see a lot more often, but receivership is a different type of distress. That's the most common, time that I see receivership actually occur.
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Matthew E. Rappaport: Then, write 1031.
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Matthew E. Rappaport: I have a whole section in here on 1031, but all of y'all folks are gonna have to read it on your own time, because we don't have enough time this morning to cover the 1031 nuances, but there's about, like, 18 slides in here on 1031s that may occur out of receivership, foreclosure, or deed in lieu. It is possible. There is a ton of legal ambiguity around a lot of issues. I got the chance to ask the IRS about some of those issues in April.
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Matthew E. Rappaport: And they said, well, that's interesting, why don't you come in for a PLR, and we might rule on that. So, for any folks that are watching this that may have interest in folks that are enacting 1031 exchanges, you're not going to get it out of a Chapter 7 bankruptcy, but you may get it out of a Chapter 11 for an operating business that owns its real estate and would like to get financing by selling the real estate.
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Matthew E. Rappaport: It's an option, but it's complicated, and I don't know how often it's been tried, because there are a lot of legal hurdles around it. But on the deed in lieu and foreclosure, we do 1031s out of those all the time. All the time.
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Matthew E. Rappaport: Because even though you have the property that's quote-unquote underwater, there's no equity in it, you're not gonna get cash, you get a lot of phantom income.
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Matthew E. Rappaport: i.e, you get income from the idea that there's a difference between the outstanding debt principal and the basis of the property, that is still taxable gain.
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Matthew E. Rappaport: Even though all the cash is going to pay back the lender.
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Matthew E. Rappaport: So, you still take a major phantom, debt… a phantom income hit in the event that you have a 1031 exchange with underwater property.
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Matthew E. Rappaport: And it could still mean less out of pocket to do a 1031 on distressed property, so it's a big thing, right? Let's talk about some of the consequences here, tax-wise, now that we understand non-tax-wise what some of the options are.
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Matthew E. Rappaport: Cancellation of indebtedness income. I just want to say this, right?
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Matthew E. Rappaport: Cancelation of debt income is broadly reserved in the real estate world for what happens when you have recourse debt that is forgiven in part or in whole, right? Cancelation of debt? It's ordinary income. It's the amount of debt canceled even if it is,
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Matthew E. Rappaport: Even if it… is partial.
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Matthew E. Rappaport: Now, right? Non-recourse debt.
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Matthew E. Rappaport: As I mentioned, non-recourse debt is anything where the taxpayer does not have a full and unconditional personal guarantee. Tufts was a major, major case in the United States Supreme Court.
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Matthew E. Rappaport: Basically, what happens is, if you have a deed-in-lieu or other sort of similar transaction to send the keys back to the bank on satisfaction of non-recourse debt.
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Matthew E. Rappaport: It is treated as a sale equivalent.
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Matthew E. Rappaport: And the non-recourse indebtedness amount is considered the amount realized.
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Matthew E. Rappaport: then you subtract the adjusted basis of the property, and you get the income associated with it. Typically speaking, once you get past depreciation recapture and other sorts of special items, the income from this is typically capital, but keep in mind that the depreciation recapture, depending on cost segregations and a number of other things.
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Matthew E. Rappaport: could be partially ordinary, or it could be partially elevated capital amounts, such as unracaptured Section 1250 gain, which is unrecaptured straight-line depreciation, etc.
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Matthew E. Rappaport: And, you know, there could be different modifications to that, but largely speaking, it's colloquially referred to as capital gain in that scenario. On the other hand, right.
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Matthew E. Rappaport: The recourse debt. Recourse debt is generally considered to be cancellation of indebtedness income to the extent that the value of the property doesn't satisfy the total amount outstanding. I mean, for instance, if you have a property at $200,000 a basis, it's worth $800 grand by agreement between you and the bank, but the bank is forgiving, you know,
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Matthew E. Rappaport: a million dollars.
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Matthew E. Rappaport: of principal indebtedness. You have a $200,000 excess. Property's worth $800.
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Matthew E. Rappaport: The debt is a million. Therefore, when you go ahead and give that back to the bank.
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Matthew E. Rappaport: part of it is considered a sale, where you have, you know, the 800 grand worth of property that you're giving back. That leaves you with 600 grand worth of, you know.
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Matthew E. Rappaport: Basically, as I say colloquially, capital income, even though not all of it's going to be capital in most scenarios, then you have $200,000 of excess. That's ordinary income. Cancellation of debt income, effectively. And we go into some specifics on that a little later on in the slides.
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Matthew E. Rappaport: There are exclusions, however, so when you have recourse debt.
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Matthew E. Rappaport: And CODI, cancellation of debt and income, right? There are exceptions. What are the exceptions? Insolvency. The insolvency is… is really under… again, only under Section 108. You don't get this for non-recourse debt. You get it only for recourse debt and cancellation of debt income.
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Matthew E. Rappaport: However, there is testing that I go over, right? And that'll get you an exception for part or all of it.
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Matthew E. Rappaport: Chapter 11. If you are in Chapter 11, COD is excluded from income. Generally, though, the sale income is not, and we'll talk about that. And then you have, really, what is a pretty beautiful section of the code here, which is QRPBI, qualified real property business indebtedness.
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Matthew E. Rappaport: And qualified real property business indebtedness leads you to the,
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Matthew E. Rappaport: Potential solution, where you start reducing basis dollar for dollar.
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Matthew E. Rappaport: before you take any sort of hit, even if you keep the property. So if you have a cancellation of debt scenario, where you've got recourse debt outstanding, and then you turn around and you get that reduced, you can instead reduce the basis of the property to… on QRPBI,
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Matthew E. Rappaport: Rather than taking a straight-up debt hit, which on regular operating business debt.
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Matthew E. Rappaport: you generally can't do. So, it's a pretty cool advantage to have the QRPBI provisions of Section 108, because what it allows you to do is you take a basis reduction hit, and only when basis and other tax items
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Matthew E. Rappaport: are reduced to zero, do you get an ordinary income hit? That's pretty cool, right? What are the different attributes that you can reduce?
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Matthew E. Rappaport: Right? Well… you know, it's for QRPBI and other eligible scenarios.
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Matthew E. Rappaport: You reduce your tax basis, but you also reduce, even before you get to the tax basis, if the taxpayer has net operating losses, right, whether they're carryovers or for the current taxable year, you can use those.
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Matthew E. Rappaport: Tax credits, which in the world of real estate holding companies, those general business and minimum tax credits are rare.
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Matthew E. Rappaport: Then, capital loss carryovers, which are pretty common too, right? You can reduce those, even though it's COD income, so you get the, offset of the capital loss carry-forwards as a tax attribute, which, under normal scenarios, you would not be able to do. There's a character mismatch. Capital losses cannot offset ordinary income.
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Matthew E. Rappaport: Then you reduce your tax basis, your passive activity loss and credits, and then your foreign tax credits, which again, in the real estate holding company land is pretty rare. But potentially.
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Matthew E. Rappaport: for, you know, other operating businesses, those stuff, those things could be broadly relevant, right? Insolvency. It's really liabilities over the fair market value of the assets, right? It's a relatively mechanical calculation.
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Matthew E. Rappaport: It's different depending on the taxpayer. Not gonna go into the nuances, because we don't have time, but the insolvency calculation in general, right, is done a little differently. S-Corps and C-Corps do it for the corporate level, even though S-Corps are pass-throughs.
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Matthew E. Rappaport: Partnerships, right?
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Matthew E. Rappaport: You don't do it at the partnership level, you only do it for the partners, and the same goes, of course, for individuals. Individuals do it at the individual level.
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Matthew E. Rappaport: If you're solvent, however, and you're not in bankruptcy, so you don't have the, you know, CODI exceptions, and you don't have the ability to offset tax attributes, right? What happens?
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Matthew E. Rappaport: Well, okay, if you're solvent, and you generally have a discharge of indebtedness, unless you have the QRPBI, which I'm going to talk about, because the QRPBI is relevant, and I did touch on it a little bit earlier, but there's some detail on the next slide.
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Matthew E. Rappaport: You're gonna have, income for, any recourse debt that's going to be either reduced or completely forgiven, and if you go ahead and you do a settlement, it's considered to be a reduction to the extent that the lender takes a hit from debt principle.
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Matthew E. Rappaport: So let's talk about QRPBI for a second, right?
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Matthew E. Rappaport: Not all real property debt is going to be QRPBI, but most of it is, right? Real property has to be used in a trade or business. It's not personal property or investment property. Investment property is a bit of a bummer, because for triple net leases, you're gonna fall outside of QRPBI, generally. That's a pure investment, unless you have an entire portfolio of triple net leases, which is a bit of a nuanced analysis.
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Matthew E. Rappaport: You cannot do it for your personal residence, you can't do it for vacation homes. You can do it for, for, you know, multifamily sorts of investment, hotels, parking garages, things like that.
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Matthew E. Rappaport: The debt has to be secured by the real property, that's academic. You know, and again, for debt that's incurred or assumed on or after 1193, which should be everything you deal with by now, right? It's got to be qualified acquisition and debt in this, which means it can't be for… in a nutshell, it's gotta be to build or acquire the property, it really can't be to cash out
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Matthew E. Rappaport: refi. If you did a cash-out refi, you fall out of QRPBI, unfortunately. And then you have to make an election, which is also academic.
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Matthew E. Rappaport: C-Corps don't have this. I have seen real estate being C-Corps, but, like, man alive, what are you doing? Like, it's a rare bird, but I still see it every now and again, and, like, you should not have real estate in a C-Corp unless you're a REIT. But at any rate, right?
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Matthew E. Rappaport: you… you know, you can't claim QRPBI, there is a limitation, you can't claim it for, like, everything, everything. It's to the extent that exceeds FMV,
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Matthew E. Rappaport: or, you know, the second prong, it's a lesser-of analysis, right? The total adjusted basis, like, immediately before discharge. So if you've depreciated down to nothing, you're gonna be in some real trouble trying to claim QRBBI on some stuff.
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Matthew E. Rappaport: But,
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Matthew E. Rappaport: if you have it, right, it's… it's… it's pretty magical, because at the end of the day, if you claim the QRPBI part, I talked about reduction of tax attributes a couple of slides over.
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Matthew E. Rappaport: But at the end of the day, if you use the QRPBI rules instead, you're just going to take a straight basis reduction for the extent that you exclude your cancellation of indebtedness from income.
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Matthew E. Rappaport: So, the overall QRPBI takeaway is, if you have the availability of the exception, you can go ahead and reduce basis, rather than taking a tax hit, but you do need to reduce basis instead. And that just kicks the can down the road. It makes the gain preserved for,
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Matthew E. Rappaport: future recognition. Okay.
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Matthew E. Rappaport: So, are you in bankruptcy, right?
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Matthew E. Rappaport: that's really… we talked about that as the other factor to look into. If you're not in bankruptcy, right, you're… again, we talked about tax attribute reduction, and then you turn around and you take the remaining canceled debt after tax reduction analysis is gone, tax attribute reduction.
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Matthew E. Rappaport: has already been exhausted, you go ahead and you have that as an ordinary income hit. In bankruptcy, however, the whole thing gets wiped out. So that's why a lot of… you have a lot of Chapter 11s for real estate folks.
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Matthew E. Rappaport: There are some cool exceptions in the real estate world, like, for instance, seller financing, right? We talked about the QRPBI exception, you've got bankruptcy, and you've got insolvency. But what about, seller financing? In the seller financing world.
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Matthew E. Rappaport: You can treat reduction of principle
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Matthew E. Rappaport: of what they call a PMM, Purchase Money Mortgage. That's seller financing, where you actually have the seller taken paper, right? If you reduce the face on the seller taken paper, you can treat that as a purchase price adjustment, which means that overall tax basis goes down.
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Matthew E. Rappaport: Right? To the extent that basis is available, but you have to make sure that the taxpayer is, solvent, and you have to make sure that the property seller, the original seller, has not moved the paper to somebody else. But if the seller holds the paper, and the taxpayer is solvent, not in bankruptcy, you can go in, even if you have a non-recourse mortgage.
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Matthew E. Rappaport: you know, you can say, okay, instead what we're gonna do is we're gonna treat it as a retroactive purchase price adjustment. Pretty legit!
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Matthew E. Rappaport: So again, you kick the can down the road. Instead of taking a capital gain hit, like, right now or something, you know, you can go ahead and you can reduce the property's basis. So the theme that you see on distressed real estate stuff
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Matthew E. Rappaport: Is that you can reduce basis or eat up tax attributes, rather than take an ordinary or capital income hit.
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Matthew E. Rappaport: on the amount of the face of principle that really gets reduced. And that's really,
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Matthew E. Rappaport: That's really nifty. That's, that's convenient. If a seller financing, you know, ends up in a repossession or a foreclosure, right, if it's non-recourse seller financing, then the… it's going to be treated as a sale transaction. But if you have a,
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Matthew E. Rappaport: You know, if you have recourse debt, right, then anything that is in excess of the value of the property at the time
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Matthew E. Rappaport: Right? If you have principal of the debt that is in excess of the fair market value, just like the example I gave before, the excess is most often cancellation of indebtedness income, which is ordinary. Here's some rules for partnerships that you could read on your own time, but
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Matthew E. Rappaport: you know, there's some nuances for partnerships. What about workouts, right? What if you go ahead and instead of having a principal reduction or a foreclosure or something, you modify the debt?
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Matthew E. Rappaport: Well, right?
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Matthew E. Rappaport: If the modifications result in no reduction or increase in principle, or even if there's an increase in principle, right? You can go ahead and,
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Matthew E. Rappaport: you know, safely say there's not going to be any cancellation of debt income, because the principle remains the same. That's pretty intuitive, right?
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Matthew E. Rappaport: What about, you know, reductions to principal?
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Matthew E. Rappaport: But also potential non-significant modifications. Usually, a reduction to principal qualifies as significant unto itself.
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Matthew E. Rappaport: But there are other sorts of things where the government doesn't consider them, and this is not only relevant on the borrower side, it's relevant on the lender side, for those of you who represent and do any work with lenders.
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Matthew E. Rappaport: But…
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Matthew E. Rappaport: These lists, that we have here, right, are sort of non-significant modifications where it's like, look, this isn't substantial enough for us to consider this the replacement of the old debt.
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Matthew E. Rappaport: with an instrument of brand new debt, right? Accounting or financial covenants. If they're customary, and the definition of customary is in the regulations, I have some examples and stuff like that, but… but…
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Matthew E. Rappaport: You know, those are not considered significant enough.
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Matthew E. Rappaport: mere forbearance up to 2 years. You see forbearance all the time.
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Matthew E. Rappaport: Right?
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Matthew E. Rappaport: 2 years plus any additional period of good faith negotiation, it's not significant enough. But if you have forbearance for longer than that, it could be.
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Matthew E. Rappaport: However… Okay?
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Matthew E. Rappaport: You will have, right, if you have a reduction in principal and any of the following modifications, you're looking at, you're looking at COD income.
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Matthew E. Rappaport: Number one, change in the interest rate. Very common. If you change… if you have a change in the interest rate, you're probably going to have a significant mod, and therefore you're going to have cancellation of debt income on that.
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Matthew E. Rappaport: If the debt's publicly traded, which is really… it's very rarely relevant to the people that I represent, it could be relevant to the people that you represent, but if it is, then anybody tuning in really knows those nuances already.
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Matthew E. Rappaport: You know, and those are just two examples, by the way. There are other examples in the regulations, but generally speaking, if you have a significant modification and a principal reduction, you're going to have cancellation of debt income to the extent of the principal reduction.
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Matthew E. Rappaport: What about sales and foreclosures? We've generally talked about this in overview. If you have recourse debt.
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Matthew E. Rappaport: The amount of principle that the value of the property doesn't satisfy
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Matthew E. Rappaport: If you're let off the hook for the rest of it, that's cancellation of debt income, it's ordinary. In the event that it's non-recourse, however, it's treated as a sale. The amount realized in the sale is the principle of the forgiven debt, you take that against basis, and there is capital income.
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Matthew E. Rappaport: That's why people like the idea
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Matthew E. Rappaport: Of doing a 1031 out of…
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Matthew E. Rappaport: Deed in lieu and other foreclosure-type transactions, because you end up with this income issue.
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Matthew E. Rappaport: Okay? And it's phantom income. You don't get the cash because the property's underwater, but you do have the income. 1031-ing typically involves the exchanger kicking in equity out of pocket.
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Matthew E. Rappaport: to buy very high-leveraged, publicly available, syndicated property. If you do that, right.
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Matthew E. Rappaport: The overall amount in the city of New York for a resident of the city of New York who's subject to city tax.
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Matthew E. Rappaport: You could, even on a capital income transaction, you could be seeing 35% overall marginal rates between federal, state, and city. If you are able to put up 15% equity.
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Matthew E. Rappaport: out of your pocket, to do a full 1031 exchange, to kick the can down the road, you are typically ahead very, very far.
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Matthew E. Rappaport: on overall cash out of pocket. It's better than taking the tax hit. And that's why 1031 as a solution is good even in the, deed-in-lure foreclosure of non-recourse debt context. However, right?
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Matthew E. Rappaport: Keep in mind, and this is the last thing I'll leave off with before I turn it back to Yoni to wrap it up.
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Matthew E. Rappaport: In recourse debt scenarios, It is… the rules are clear, okay, that to the extent of forgiveness of recourse.
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Matthew E. Rappaport: Debt.
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Matthew E. Rappaport: you cannot have a 1031 offset that amount, even if you take recourse purchase debt on the other side of the transaction, the up leg. Because recourse debt and CODI, in general.
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Matthew E. Rappaport: is not treated as being 1031-able. If you have a total forgiveness not replaced by the value… not covered by the value of the property that's given back to the lender.
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Matthew E. Rappaport: That is not an exchange. That is a raw forgiveness of debt. Take the example I had at the beginning of the presentation. $800,000 of debt, $200 of basis.
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Matthew E. Rappaport: and a million of face. The $200,000 is not considered part of the sale of the property as a leg of the exchange. It is a raw forgiveness of debt. If you have that scenario, the recourse debt must be recognized. Other than making charitable donations and having some other type of offsetting deduction from a different source.
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Matthew E. Rappaport: There's nothing you can do about that 1031-wise. You have to only take the amount
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Matthew E. Rappaport: that the property was worth, and you can 1031 that part. You can't 1031 the forgiveness of recourse debt. And I hope we covered some good ground there. Yoni, you can wrap us up, but I hope it gave everybody some insight in terms of how these situations are treated.
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Jonathan Shenkman: Great, thank you so much, Matt. And if anyone has any specific questions, new business opportunities, any other issues they'd like to discuss, please feel free to reach out directly to Matt or myself where appropriate, and I'll be sure to include his contact information in the follow-up email to this program. And as I mentioned at the onset, the goal of these programs is to stay up-to-date on timely wealth management-related topics.
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Jonathan Shenkman: and to collaborate where appropriate. And I think we can all agree that the clients who are best prepared are the ones who are served by a team of knowledgeable advisors.
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Jonathan Shenkman: Three more quick items before I let you go. First, my next webinar's on Thursday, September 18th at 8.30am, featuring Bruce Steiner of Kleinberg Kaplan, based in New York City, who'll be speaking on the topic of snowbird Domicile and choice of law, and I'll be sure to send out the invitation to this program in the coming days. In the meantime, I'd love to continue to grow this webinar community, so if you have a friend, colleague, or client who'd like to be notified of my upcoming webinars.
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Jonathan Shenkman: They can email me with the word webinar on the subject line. I'll add them to my webinar distribution list. My email is jonathan at parkbridgewealth.com. Second, you can follow all my work on X and Instagram at Jonathan on Money, and by connecting with me on LinkedIn, you could also listen to my weekly podcast called Jonathan on Money, which is available on Apple, Spotify, or wherever you get your podcasts, and you can watch my practical planning videos, which I post several times a week.
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Jonathan Shenkman: by following me on YouTube at Jonathan and Money as well. And third, please take 30 seconds to fill out my survey at the end of this program. It helps me improve my webinars and provide timely and interesting content to attendees. I thank you in advance for that. And with that, this concludes today's session. Please stay safe and healthy, and have a wonderful day, everybody.