Distressed Owners of Commercial Real Estate on the Hook for Hefty Tax Bill

When the economic downturn hit, it brought real estate values plummeting. Now that prices have returned to near pre-recession levels, however, some landlords hardest hit by the distress that cropped up during the tumult could be on the hook for a hefty tax bill.

The issue traces to a common scenario in the kind of workouts that were often done to bring a building back from the brink of financial trouble.

To get at distressed property, many prospective buyers bought the debt tied to a building—often at a discount—in order to seize the asset. Rather than go through costly and arduous foreclosure proceedings, however, these note holders often dangled small continued ownership stakes in a building in order to induce the existing landlord to voluntarily hand over the keys.

recession Distressed Owners of Commercial Real Estate on the Hook for Hefty Tax BillNow that the city’s investment sales market is roaring again, owners who purchased during the low point in the market have been increasingly eager to sell in order to cash in on their profits. It’s the previous owners who tagged along for the ride as minority stakeholders who may find themselves in a sticky situation.

Many of those formerly distressed landlords had depreciated their assets, a common tax technique utilized by owners. When the property resells, those owners are on the hook for the difference.

“If you bought at $100 million and you depreciate your building to $50 million and then sell it for $80 million, you have to repay the taxes on that $30 million,” Demetri Yatrakis, a tax attorney at WeiserMazars LLP, told The Commercial Observer.

Normally landlords who profit on a sale don’t worry about such repayments. The issue is difficult for those former distressed landlords who might not have recouped any actual equity in the sale, due to the fact that prices in general still have not returned to their frothy peaks during the boom years of 2005-2008, when many broken deals were made.

“They’re being stuck with a tax bill even though they lost money in the deal,” Mr. Yatrakis said.

Mr. Yatrakis has already seen owners in this position come to him in order to structure a 1031 exchange, which would shelter them from the tax bill. The unusual aspect of this is that owners typically pour profits from a sale through such a structure into another asset, tax free.

In these cases, the owners have no equity and hence are seeking not to transfer any money through the exchange but simply avoid the tax.

“We’ve already done a few of these deals in Florida where the market was really bad,” Mr. Yatrakis said. “But you could definitely see instances where it might crop up in the city too.”

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