Marks Paneth Real Estate Perspectives Summer 2019

4. The conduit loan lender assigns the mortgage loan to the new lender and releases and dis- charges the borrower from all claims, liabilities and obligations under the conduit loan. Following these steps, the borrower is able to sell or refinance the property subject to the promissory note and mortgage now owned by the new lender. In an in-substance defeasanc e, the original borrower’s debt is not legally discharged, and the borrower remains legally liable to the lender to make required payments under the loan in the event there is a shortfall in cash flow generated by the substitute collateral. Thus, the borrower is not eligible for an immediate deduction of a defeasance premium attributable to an in-sub- stance defeasance. Instead, the defeasance premium may only be deducted over the remaining term of the conduit loan. Commercial real estate owners, borrowers and investors interested in refinancing their securitized loans should consider all the costs associated with a defeasance transaction as well as any possible tax deductions. If a defeasance is necessary, these individuals should consult with a defeasance consul- tant, their attorneys and especially their tax advisors to make sure a legal defeasance is achieved and the appropriate deductions are taken. TIP: AVOID IN-SUBSTANCE DEFEASANCE CONCLUSION

A LEGAL DEFEASANCE

In a legal defeasance, the borrower is legally released from any continuing liability on the debt. The substi- tuted collateral purchased to defease the loan is treated as a repayment of the original loan. The loan is retired from the perspective of the borrower. A defeasance premium paid under a legal defeasance is deductible as a payment of interest in the year incurred. A TYPICAL LEGAL DEFEASANCE The transactional steps of a typical legal defeasance are listed below. 1. In order to implement the defeasance, a conduit loan borrower borrows money and executes a defeasance promissory note from a new lender. The amount borrowed from the new lender is equal to the outstanding principal of the borrower’s existing conduit loan. 2. The borrower is then required to use the pro- ceeds of the new loan to purchase U.S. govern- ment securities to serve as collateral for the new loan. The purchased U.S. government securities must generate sufficient cash flow to make all remaining debt service payments of the existing conduit loan. 3. The new lender then assigns its promissory note and its rights to the U.S. government securities serving as collateral for the new loan to the conduit loan lender.

Eduard Suleymanov, CPA is a Director in the Real Estate Group at Marks Paneth LLP. Mr. Suleymanov specializes in providing tax and consulting services to commercial and residential real estate clients, including real estate management firms and high-net-worth property owners. He can be reached at esuleymanov@markspaneth.com or 212.710.1776.

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Real Estate Perspectives

SUMMER 2019

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