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Exchange Basics


Exchange of Property to Avoid Foreclosure

  1. It is not uncommon for real estate developers to acquire real estate that was 100% leveraged. However, to what extent can a taxpayer transfer property with no equity in a Section 1031 exchange and thereby avoid the tax consequences that would otherwise result from a foreclosure (or a deed in lieu of foreclosure)?
  2. Furthermore, disposing of the property in a taxable sale could trigger suspended passive losses from the property, and the gain may be passive or non-passive, depending on the facts and circumstances.
  3. Alternative minimum tax considerations also come into play.
  4. A deed in lieu of foreclosure can permit some timing benefits, compared to a straight foreclosure.
  5. Where the "Qualified Intermediary" safe harbor is used the IRS may have great difficulty in successfully contending that a transfer to an intermediary who retransfers the property to a receiver or the bank in lieu of foreclosure is not eligible for non-recognition treatment under Section 1031. It is understood that the IRS National Office had a ruling project on this topic under consideration. Until further guidance is issued, taxpayers should realize that there is some risk in going forward with such an exchange.

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