Real Estate Forum - May/June 2009

one’s ability to hold a single-asset for a long time period is not possible today. “There’s certainly a new dynamic for what’s occurring,” he says. “The ability for banks to formulate and give their own plan after the initial debtor plan period will make it quicker for lenders to resolve single-asset cases.”

“You have to convince the lender
that it’s worth waiting for. That
alignment of interests is what will
get us through the cycle.”

JOSEPH RUBIN

PRINCIPAL, TRANSACTION REAL ESTATE

“It’s very important to understand the big picture and then start developing strategies on an asset and a lender level and come up with alternatives: I want to defer, I want to reduce the payments, I want to do debt-for-equity swaps,” explains Rubin. “There’s a whole host of cards that you can play, it’s like a toolkit that you have. It’s slogging it out, that’s what it comes down to.”

Just as preserving cash and building a war chest is critical for a successful restructuring or bankruptcy, Rubin notes that it’s equally as important for lenders to be realistic about market conditions. “Lenders today have to realize that things need to be restructured to get through this period,” he says. “The whole thing is: ‘Give us enough time to effectuate our business plan.’ You have to convince the lender that it’s worth waiting for. That alignment of interest is what will get us through the cycle. Everybody feels like they’ve got skin in the game.”

Also imperative is understanding the tax ramifications in each alternative restructuring. “You could say you’re going to reduce your debt by so many millions of dollars. But if you do that, you might have a tax liability of millions of dollars, and you don’t have the cash to pay the tax,” Rubin states.

Richard Solway is the partner that brings tax expertise to the table. He works with both distressed investors and debtors as well as investors looking to merge with, buy or invest in distressed companies.

Particularly for public companies, tax is a significant part of a firm’s cash flow. When doing asset sales or restructuring debt, it’s necessary to protect the cash of the debtor and understand the proceeds that will be available to the ultimate equity holders after tax.

One of the key factors to most deals, from a tax perspective, is preserving the tax basis of the target. And, since tax rules vary and shift, investors may not necessarily know offhand the nitty gritty details that a tax expert would. “One of the biggest issues in any acquisition is that somebody does the deal too quickly without really looking at the risks,” says Solway. “Diligence is critical on the tax side, particularly to ensure you’re not buying into problems from the past, and also as you think about what you want to do with the target going forward.”

As an example, the executive cites the importance of obtaining a step-up in the fair value tax basis of the acquisition target, in the case of a merger. Let’s say a firm took a public company private a couple of years ago—similar to the

26 REAL ESTATE FORUM MAY/JUNE 2009

privatizations in the gaming and hospitality arena. If those buyers didn’t get a step-up in the tax basis of the acquired firm’s assets, that would carry over to the next hand-off. Some time later the buyer decides to sell the target to a new investor, or break it up and sell to several investors. The straight deal, on a pre-tax basis, may look attractive. But, says Solway, if there’s a low tax basis in those assets—because the buyer didn’t get the step-up—there still may be a sizable tax gain when they sell those assets. That also means there will be a tax cost, too, so the proceeds aren’t nearly as much as they initially expected. These are the types of issues that many investors don’t immediately think about when doing these deals, but can have a great impact on the bottom line.

According to Solway, there are three major issues that impact the real estate industry from a tax perspective. The first is a recently passed law for cancellation of debt, or COD, income—a new COD deferral rule. Whereas in the past, in a debt exchange or repurchase of debt at a discount, the debtor would have to pay tax on the COD income, now the issuer can get five-year deferral income, during which the COD is recognized as taxable income on a straight-line basis. Today, though, many firms are modifying debt, not necessarily buying back or refinancing debt, and there’s usually a fee involved. “If that fee causes the yield on that debt to change by more than 25 basis points, they actually trigger a signifi-

“Diligence is critical on the tax
side, particularly to ensure you’re
not buying into problems from
the past.”

RICHARD SOLWAY

PARTNER, REAL ESTATE TAX

cant modification for tax purposes,” points out Solway. “It’s treated as if they bought back their old debt at a discount and issued new debt, ending up with COD income. It’s very easy to trigger COD income on the tax side—that’s one of these pitfalls that some people aren’t aware of.”

Second is the recent change-in-control rules under Section 382, which can impact a company’s tax or, in the case of a REIT, a taxable REIT subsidiary’s net operating losses. These changes can affect a firm’s go-forward depreciation deductions, limiting those deductions.

The final issue relates to asset sales or divestitures a distressed debtor may look to do in an effort to raise cash. This is usually what distressed debtors try to do before they do file for bankruptcy—as is the case with a lot of companies under duress in Las Vegas.

“There the question comes up—what are my net proceeds of that asset sale and, if I’m going to get hit with a lot of tax on it, is there a way to structure it so I can generate cash, but defer the tax gain?” he says. “Those are real issues relating to your ultimate proceeds and cash flow that. They’re not just technical tax issues, they’re real economic considerations.”