Non Recourse Loan Essay

598 WordsApr 3, 20133 Pages
Research Paper: ACCT 308 Facts: A borrower has an outstanding balance on a real estate mortgage of $1.5 million that he may be personally liable for. His basis in the property is $1 million dollars while the property’s fair market value is $1.2 million dollars. The property is repossessed by the bank and he is insolvent both before and after the repossession. Issues: What taxable gain is recognized by the buyer, if any, if it was recourse debt? What taxable gain is recognized by the buyer, if any, had it been nonrecourse debt? Authorities: IRS Publication 4681 (IRS database) Commissioner v. Tufts, 461 U.S. 300 (1983) IRS Sec. 108(a)(1)(B) Conclusion: Since the borrower was insolvent both before and after the repossession, there is no taxable income, only taxable gain of $200,000 on the recourse debt. Had it been nonrecourse debt, the taxable gain would be $500,000 equal to the outstanding balance minus the borrower’s basis in the property. Analysis: According to IRS Publication 4681, if the borrower was personally liable there is taxable gain that is to be recognized. The amount of gain on the foreclosure is “the difference between the amount realized and your adjusted basis in the transferred property.” To clarify what the amount realized is for the recourse debt, they say it is the lower of “the outstanding debt immediately before the transfer… or the fair market value of the transferred property”. In this case, the borrower’s fair market value on the mortgage property ($1.2 million) is less than what he owes ($1.5 million) so the FMV less the adjusted basis of the property($1 million), he recognizes a 200,000 gain on the recourse debt. Typically the gain would be characterized as “ordinary income from the cancellation of debt” per IRS publication 4681 Section 2. However, since the borrower is insolvent before and after the repossession

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