Real Estate & Passthrough Planning

In light of the current economic environment during which loans are being bought and sold at discounts, buyers of nonpublicly traded loans and their tax advisors may be surprised to learn that a seemingly minor loan modification may be considered "significant" and thus sufficient to cause a buyer to recognize taxable income on the deemed debt-for-debt exchange. From a public policy perspective, the tax law should encourage purchasers of debt on the secondary market to work with cash-strapped borrowers to modify distressed loans as necessary to avoid foreclosure and/or bankruptcy. A tax rule that requires a purchaser to recognize "phantom income" pursuant to a workout of distressed debt creates a strong disincentive to the achievement of such a workout. Over the last decade or so, sales of packages of loans by original lenders (whether pursuant to securitization structures or otherwise, and often at a discount to face value) have become quite common, if not the norm. As a result, the problem described above potentially could affect many buyers of discounted debt that is subsequently restructured.