10A — July 22 - August 18, 2022 — Tax Issues/Accounting — Financial Digest — M id A tlantic Real Estate Journal
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T ax I ssues /A ccounting
By Lynn Mucenski Keck, CPA, MST The tax break commercial real estate investors might need after COVID-19
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The decrease in debt princi- pal is often referred to as a discharge of indebtedness or cancellation of indebtedness. Under certain circumstances, the Internal Revenue Code al- lows for income related to the cancellation of indebtedness to be excluded from a taxpayer’s income in instances of a title 11 (bankruptcy) case or where the taxpayer is insolvent. Insol- vency is defined as the excess of the liabilities over the fair market value of assets. The ability to claim insolvency at the entity level is limited to C and S corporations. For partnerships, the most com- mon entity type for real estate holdings, insolvency must be measured at the individual partner level. This can pose an issue because, often times, the individual partners are solvent (i.e., not insolvent). However, being insolvent or in bankruptcy is not the only way that taxpayers involved in real estate can exclude cancel- lation of debt income. Provided the taxpayer is not a C cor- poration, cancellation of debt income can be excluded if the debt discharged is considered qualified real property busi- ness indebtedness (QRPBI). QRPBI is debt that is incurred or assumed by the taxpayer in connection with real property
and adjust her basis in her real property by $50,000 as of January 1, 2022. If the property is not held directly by an individual, but instead is held by a partner- ship, then the determination of whether debt is QRPBI (and the application of the FMV limita- tion) is made at the partnership level. However, the decision as to the basis reduction is made and elected at the partner level. This allows each partner to weigh their unique individual income tax circumstances and come to their own conclusion. Individual taxpayers, includ- ing partners in a partnership, must file Form 982 to defer the treatment of cancellation of debt income and elect to reduce their basis in depreciable prop- erty. Such an election must be made on a timely filed return, including extension, and can only be revoked with the con- sent of the IRS. For real estate investors who restructured certain real prop- erty debts due to the COVID-19 pandemic, the ability to defer the cancellation of debt income could be a great tax planning opportunity, allowing them to avoid immediate taxable in- come and IRS cash payments. Lynn Mucenski Keck, CPA, MST is principal at Withum. MAREJ service and knowledge that sets agencies, such as Surety, apart. Having ‘family’ in the name is more than words. It is part of the culture and evident at every level of the organization. Open communication is encouraged, leading to an environment where there are no barriers and employees’ ideas flourish.” The South Jersey native who when not working might be found fishing, hiking or at the shore goes on to add, “I’ve worked for two other title companies and hands down, the commit- ment to service is unmatched at Surety and I look forward to furthering our growth with the dedicated Souder Team.” “Nick is a force to be reckoned with,” said Red Bank Branch Co-Managers, Christina Meyer and Debbie Freedman. “His passion for superior customer service paired with honing and improving his skills every day make him a pleasure to man- age. We are very excited to be on this journey with him.” MAREJ
he COVID-19 pan- demic has had a dramatic impact on
used in a trade or business and is secured by such prop- erty. For property acquired on or after January 1, 1993, QRPBI includes debt used to acquire, construct, reconstruct, or substantially improve real property. Whether a taxpayer is engaged in a trade or busi- ness is not always an easy question to answer and rental arrangements utilizing a triple net lease need to be carefully reviewed to ensure they qualify as a trade or business. As always, there is a catch. The IRS is not going to allow an exclusion from taxable income out of the kindness of its heart. Instead, the Internal Revenue Code essentially allows a swap; in exchange for an exclusion of cancellation of debt income re- lating to QRPBI that is not due to insolvency or bankruptcy, the rules allow a taxpayer to elect to reduce the tax basis of the taxpayer’s depreciable real property under section 108(b)(5). The amount of the exclusion and basis reduction is the excess of the outstanding principal amount of the debt less the FMV of the business real property immediately before discharge. The FMV of the property is reduced by any other qualified real property debt secured by the property. Let’s look at an example. mitment to making sure that our tax structure is attractive to businesses and individu- als and supports our growing economy,” said Governor John Carney. “That, along with Delaware’s low cost of living, plus top-notch healthcare, education and recreation, add up to one great place to live.” About Delaware Prosperity Partnership Delaware Prosperity Part- nership leads Delaware’s eco- nomic development efforts to attract, grow and retain busi- nesses; build a stronger entre - preneurial and innovation eco- system; and support employers in place marketing Delaware to potential employees, highlight- ing Delaware as a great place to work, live and play through its LiveLoveDelaware website. DPP advances a culture of in- novation in Delaware, working with innovators and startups to spotlight and celebrate suc- cesses and connect them with the resources they need to suc- ceed. MAREJ
Assume that Julia acquires a building in 2018 that she uses in a trade or business. In 2021, the building is subject to a first mortgage of $110,000 and a sec- ond mortgage of $90,000. The FMV of the building in 2021 is $150,000. In 2021, Julia’s bank agrees to reduce the second mortgage debt from $90,000 to $30,000, resulting in cancella- tion of debt income of $60,000. The outstanding principal debt immediately before discharge was $90,000, which exceeds the FMV of the property less the first mortgage ($150,000- $110,000) by $50,000. There- fore, Julia would be able to exclude $50,000 of income and would be required to include only $10,000 of cancellation of debt income. For Julia to ensure the $50,000 is not included in taxable income, her aggregate adjusted tax bases of depre- ciable real property must be at least $50,000. The basis reduction, provided by section 1017, will apply beginning on the first day of the taxable year following the year of discharge (or immediately before the dis- position if the property is dis- posed of before the end of the taxable year). In our example, Julia would have to include the $10,000 of cancellation of debt income in her 2021 tax return MARLTON, NJ — Nick Souder of Surety Family of Companies (Surety) , a title insurance agency serving resi- dential and commercial clients in New Jersey, Pennsylvania and nationally, celebrates his one-year anniversary with two milestone announcements. The experienced business develop- ment executive has been an integral part in launching the Souder Team – a group of title industry specialists that will expand the company’s reach in Central NJ, specifically Mer - cer, Middlesex and Monmouth counties. Simultaneously Soud- er worked hand-in-hand with company management to open its new office in Red Bank and home to the Souder Team. During his busy year, he has focused on strengthening client relations and building new rela- tionships through networking. Like many who join Surety, Souder speaks highly of the company. “With title insurance being a regulated industry, it is
commercial real estate values, and in some cases resulted in property no longer being able to sup- port the debt with which it is encumbered.
Lynn Mucenski Keck
The decrease in value of com- mercial property has forced many owners to restructure their debt. However, the result- ing forgiveness of a portion of the debt does not automati- cally result in federal taxable income. Favorable rules, which were put into place for taxable years after 1992, could allow the cancellation of debt income to be deferred for federal in- come tax purposes even if the taxpayer is not in bankruptcy or insolvent—as is normally the case. Taxable income is closely linked to when a taxpayer receives economic benefit. So it makes sense that if you previously had a $100,000 bank loan and the bank de- creases the principal balance to $80,000, then your $20,000 economic benefit should be included in taxable income. WILMINGTON, DE — Ac- cording to WalletHub’s recent- ly released 2022 Tax Burden by State report, Delaware has the distinctive advantage of having the third-lowest tax burden in the United States. Delaware also has a lower cost of living than most of its East Coast neighbors, a median household income 6.3% higher than the national median and high- wage job opportunities in the manufacturing and advanced manufacturing industries. With a total tax burden of 6.22%, Delaware ranks near the top for tax favorability — only Alaska and Tennessee have lower tax burdens. The listing is formulated based on the three components of state tax burden – property taxes, in- dividual income taxes and sales and excise taxes — as a share of personal income. Delaware is one of just five states in the nation – and the only state in the Mid-Atlantic region – with no sales tax. Unlike tax rates, which vary
Delaware has one of lowest tax burdens in US widely based on an individual’s circumstances, tax burden mea- sures the proportion of total personal income that residents pay toward state and local tax- es. In addition to low total tax burden, Delaware is among the states with the lowest property tax burdens with a percentage of 1.77%. The Cost of Living Index Calculator shows how far salary goes for housing, utilities and more in Delaware.
Souder celebrates one year at Surety with the Launch of the Souder Team
Delaware also ranks among the top three states nation- wide for favorable business tax. The comprehensive report Location Matters, sponsored by KPMG and The Tax Foun- dation, assesses the business tax burden in two categories of cities — major and mid- sized — throughout all 50 states, accounting for the wide range of tax impacts faced by businesses, such as property tax, income tax, sales tax and others. “Delaware’s favorable posi- tion in national tax burden rankings underscores our com-
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