Understanding Foreclosure 1031s

Understanding Foreclosure 1031s January 24, 2023

In our November column, we discussed the benefits of zero cash flow deals, especially as they apply to single-tenant, net-leased properties and 1031 exchanges. Given the current economic uncertainty, it is necessary to revisit that overview and drill down into specifics that can help investors protect themselves as the tide turns.

We must stress upfront that we are not sounding alarms or preaching economic doom and gloom. We do not—at this point— see a return to the doldrums of 2009. Rather, we are advocating for preparedness as part of any investor’s strategic plan, come what may.

That said, our primary focus here is on office buildings, a sector that obviously still reels from the upheavals wrought by the pandemic, and now faces the impact of a potential downturn. Indeed, office foreclosures have been creeping up, by some counts as much as 104 percent since the end of 2021.

As many investors will discover, giving the keys back does not equate to being able to just walk away. The tax man will come knocking right after the lender. There is a deemed sale that occurs when you are relieved of the debt and give the property to the lender. It’s essentially selling the property at whatever balance was on the loan. If you’ve owned the property a long time, you likely have a low basis and, hence, large gain.

This is especially significant for private owners where a property may have been in their possession for years (or even decades) and refinanced multiple times. By performing a 1031 exchange with a ZCF deal, you could defer the gain you’ve incurred and likely do so with less cash than paying the tax bill.