Even if owners hand over the keys to an asset, they still may face a taxable event.
Before the Great Recession, many borrowers took out non-recourse CMBS loans. Then, when the economy tanked, they were forced to hand the keys back to the lender.
Even though the borrowers were handing over the asset, a taxable event was still being created. If a borrower with non-recourse loan hands a building back and $10 million in debt is forgiven, that is considered a gain by the Internal Revenue Service.
“You no longer have the building and you’ve received no cash in the sale,” says Avison Young Senior Vice President Rich Murphy. “But you’ve got a $10 million gain and you have to pay the tax on that gain.”
But there is a solution. “A 1031 exchange gets you over that gain the same way it would in any other scenario,” Murphy says. “The only difference here is that you don’t have any money with which to buy the replacement property.”