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March 30 — IRS guidance that says the agency would treat a nonrecourse real estate loan as recourse if it included a carve-out for a borrower who admitted insolvency would create the “world's greatest tax shelter” if the analysis weren't just plain wrong, a practitioner said.
“If this were correct, become a developer,” Richard Lipton, a partner at Baker & McKenzie LLP, said March 30 at a National Association of Real Estate Investment Trusts conference. “Developers would be allocated all of the losses from every real estate development in the country.”
The Internal Revenue Service said in CCA 201606027, released last month, that “it is reasonable to assume” that either the legal admission of inability to pay one's debt or six other standard carve-outs related to bankruptcy are likely to occur in a constructive liquidation under Treasury Regulations 1.752-2(b)(1) (25 DTR K-1, 2/8/16).
Lipton said this would mean about $600 billion worth of commercial mortgage-backed security loans, all of which include these carve-outs and more, would suddenly become recourse, making the borrower's other assets liable.
Borrowers Say No
Many real estate investment trusts engage in transactions where they are providing financing to the developer, which is usually the party that signs the nonrecourse carve-outs. Under this guidance, which is not precedential, liabilities that have been allocated to the REIT's operating partnership would instead get allotted to the developer.
“Borrowers would never sign if they thought a liability was more likely than not,” Lipton said. “In the real world, borrowers understand they do not have recourse liability on a loan that has recourse carve-outs unless they engage voluntarily in a bad act.”
This creates a problem for practitioners deciding how to report the debt on a tax return and how to properly advise clients.
Meanwhile, “to a large degree we have to stand up when the IRS issues guidance that is just wrong—and this one is just wrong—you ignore it,” Lipton said, noting real estate groups are pushing for the removal of the guidance. “We are facing the usual difficulty that it is hard to get an administrative agency to admit it screwed up.”
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