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Encyclopedia > Nonrecourse debt

A nonrecourse debt or non-recourse debt or nonrecourse loan is a secured loan (debt) that is secured by a pledge of collateral, typically real property, but for which the borrower is not personally liable. If the borrower defaults, the lender/issuer can seize the collateral, but the lender's recovery is limited to the collateral. If the property is insufficient to cover the outstanding loan balance (for example, if real estate prices have dropped), the lender is simply out the difference. Thus, non-recourse debt is typically limited to 80% or 90% loan-to-value ratios, so that the property itself provides "overcollateralization" of the loan. A lender of non-recourse debt depends crucially on an accurate assessment of the credit of the borrower, and a sound knowledge of the underlying technical domain as well as financial modeling skills. A secured loan is a loan in which the borrower pledges some asset (e. ... A security interest is a property interest created by agreement or by operation of law over assets to secure the performance of an obligation (usually but not always the payment of a debt) which gives the beneficiary of the security interest certain preferential rights in relation to the assets. ... Collateral within a financial context is used to indicate assets that secure a debt obligation. ... In finance, default occurs when a debtor has not met its legal obligations according to the debt contract, e. ... Loan to Value is an expression of the loan amount as a percentage of the total appraised value of a piece of real estate. ... Computation of corporate finance problems, standard portfolio problems, option pricing and applications, and duration and immunization. ...

Contents

Common uses

Non-recourse debt is typically used to finance commercial real estate and similar projects with high capital expenditures, long loan periods, and uncertain revenue streams. It is also commonly used for stock loans and other securities-collateralized lending structures. Because most commercial real estate is owned in a partnership structure (or similar tax pass-through), non-recourse borrowing gives the real estate owner the tax benefits of a tax-pass-through partnership structure (that is, loss pass-through and no double taxation), and simultaneously limits personal liability to the value of the investment.


A non-recourse debt of $30 billion was issued to JPMorgan Chase by the Federal Reserve in order to purchase Bear Stearns on March 16, 2008. The non-recourse loan was issued with Bear-Stearns less liquid assets as collateral, meaning that the Federal Reserve will absorb the loss should the value of those assets be below their collateralized value. JPMorgan Chase (NYSE: JPM) is one of the oldest financial services firms in the world. ... The Federal Reserve System is headquartered in the Eccles Building on Constitution Avenue in Washington, DC. The Federal Reserve System (also the Federal Reserve; informally The Fed) is the central banking system of the United States. ... The Bear Stearns Companies, Inc. ...


Characterization

Non-recourse debt is usually carried on a company's balance sheet as a liability, and the collateral is carried as an asset.


Tax consequences of disposition of property encumbered by nonrecourse debt

For U.S. Federal income tax purposes, the interaction among the concepts of (1) the "amount realized" upon a disposition, (2) the amount of nonrecourse debt, and (3) the amount of adjusted basis in the property is fairly complex. The tax consequences of a disposition depend on whether the taxpayer acquired the property with the non-recourse debt already attached, or whether the taxpayer took out the non-recourse debt after acquisition of the property, and the relative relationships between fair market value (FMV) and purchase price and disposition price. FairTax Flat tax Tax protester arguments Constitutional Statutory Conspiracy Taxation by country Tax rates around the world Tax revenue as % of GDP Part of the Taxation series        The federal government of the United States imposes a progressive tax on the taxable income of individuals, partnerships, companies, corporations, trusts, decedents estates... To meet Wikipedias quality standards, this article or section may require cleanup. ...


Basic concept: Computing gain or loss on a disposition

Upon a sale or other disposition of property under U.S. income tax law, a taxable gain generally results where the amount realized upon the sale or other disposition of property exceeds the amount of the taxpayer's adjusted basis in that property.


Generally, the amount realized is the amount of cash and other consideration received by the taxpayer. The amount of any loan forgiven or discharged is generally part of that consideration.


The adjusted basis is the sum of the following:

  • the amount of the original cost incurred by the taxpayer when the property was acquired, including the amount of any non-recourse debt assumed by the owner/taxpayer as part of the acquisition (also known as "original basis"),
  • plus the costs of improvements (if any) made by the taxpayer to the property,
  • less the amount of depreciation (or similar) deductions allowed (or allowable) to the taxpayer on that property.

If the amount realized exceeds the amount of adjusted basis, the taxpayer has realized a gain at the time of disposition. If the adjusted basis exceeds the amount realized, a loss has been incurred.


The Federal income tax effect of nonrecourse debt may be explained by first considering the tax effect of a disposition involving recourse debt (that is, a debt in which the property provides first security coverage, and the borrower/taxpayer is personally liable for any deficiency that may remain after the lender forecloses against the property), and then contrasting against similar facts involving nonrecourse debt.


Disposition of property subject to a recourse debt

Example:


1. The unpaid principal of the recourse debt is $100,000;


2. The fair market value of the property is $80,000;


3. The taxpayer's adjusted basis in the property is $45,000.


Assuming that the creditor forecloses on the property and that the $20,000 excess of the debt over the property's fair market value ($100,000 less $80,000) is contractually discharged (for didactic symmetry with the non-recourse example, let's assume, contrary to whole commercial point of a recourse loan, that the debt is outright forgiven by the creditor, with no actual payment), the taxpayer would realize the $20,000 amount as income from the discharge of indebtedness. That $20,000 of forgiveness would be taxable to the taxpayer as ordinary income even though the taxpayer received no "cash" at the time of the discharge.[1] The $35,000 excess of the fair market value over the adjusted basis ($80,000 less $45,000) would be treated as a taxable capital gain on the "sale or other disposition" of the property -- again, even though the taxpayer received no "cash" at the time of the foreclosure.


Disposition of property subject to a nonrecourse debt

Assuming the same facts except that the debt is nonrecourse, the result would be quite different. The taxpayer would realize zero taxable ordinary income from the discharge of debt. Instead, the entire $55,000 difference between the unpaid principal of the debt and the taxpayer's adjusted basis ($100,000 less $45,000) would be treated as a taxable capital gain on the "sale or other disposition" of the property -- again, even though no cash is received by the taxpayer at the time of foreclosure.[2]


At the sale, foreclosure or other disposition, nonrecourse debt incurred as part of the financing of the acquisition, and money extracted from an investment by mortgaging out, are treated the same: both are taxable realization only at the time of the property's disposition,[3] even if, at time of disposition, the property is worth less than the amount of the mortgage. Nonrecourse debt that is in place at the time of acquisition of the property is included in basis (the Crane case),[4] subsequent borrowing is not (Woodsam),[5] but subsequent borrowing proceeds reinvested in a depreciable property thereby avoid Woodsam and take advantage of Crane.[citation needed]


The application of these intepretations, through IRS Technical Advice Memoranda (TAMs), to some types of non-recourse stock loans has led to inconsistent interpretations of such transactions in recent years. Though there is no contention over whether these loans be declared in the event of a default or at loan maturity, particularly when the borrower has realized a gain over basis (thus generating a 1099 Misc Income report), tax authorities have not established any legal basis that has stood up under legal scrutiny to declare such loans "sales" universally at the outset. Still, many firms in the stock loan business have modified their "non-recourse" loans with "limited recourse" loans that are more in keeping with spirit of the original definition of nonrecourse debt and therefore likely to be more compliant with tax law, resembling a conventional loan structure[6]


Footnotes

  1. ^ Unless the $20,000 qualifies as being excludable under 26 U.S.C. § 108.
  2. ^ Commissioner v. Tufts, 461 U.S. 300 (1983). Crane v. Commissioner of Internal Revenue, 331 U.S. 1 (1947).
  3. ^ Estate of Levine v. Commissioner, 72 T.C. 780, 792 (1979), aff’d, 634 F.2d 12 (1980) (a “nonrecourse mortgage debt is a debt of the property owner since he is, in reality, a quasi-obligor on the debt, notwithstanding the fact that the debt is owed by the property.”); Woodsam Associates, Inc. v. Commissioner, 16 T.C. 649 (1951), aff’d, 198 F.2d 357 (2d Cir. 1952) (the excess of the amount of the debt over the adjusted basis of the property is gain, and will be treated as capital gain, subject to the rules on depreciation recapture).
  4. ^ Crane v. Commissioner of Internal Revenue, 331 U.S. 1 (1947).
  5. ^ Woodsam Associates, Inc. v. Commissioner, 16 T.C. 649 (1951), aff’d, 198 F.2d 357 (2d Cir. 1952).
  6. ^ (Example, limited vs non-recourse stock loan)

The Internal Revenue Code (or IRC) (more formally, the Internal Revenue Code of 1986, as amended) is the main body of domestic statutory tax law of the United States organized topically, including laws covering the income tax (see Income tax in the United States), payroll taxes, gift taxes, estate taxes...

See also

A mortgage loan is a loan secured by real property through the use of a mortgage (a legal instrument). ... Finance studies and addresses the ways in which individuals, businesses, and organizations raise, allocate, and use monetary resources over time, taking into account the risks entailed in their projects. ... Real estate is a legal term that encompasses land along with anything permanently affixed to the land, such as buildings. ... A real estate appraisal is a service performed, by an appraiser, that develops an opinion of value based upon the highest and best use of real property. ...

  Results from FactBites:
 
revrul92-53 (1216 words)
Nonrecourse debt should also be treated as a liability in determining insolvency under section 108 to the extent of the fair market value of the property securing the debt.
Thus, that excess nonrecourse debt should not be treated as a liability in determining insolvency for purposes of section 108 of the Code.
In this situation, pursuant to the prearranged work-out plan, $10,000 of A's recourse debt is discharged, and shortly thereafter $175,000 of A's nonrecourse debt is discharged.
Nonrecourse debt - Wikipedia, the free encyclopedia (723 words)
A loan (debt) that is secured by a pledge of collateral, typically real property, but for which the borrower is not personally liable.
When a debtor surrenders the collateral in exchange for the cancellation of the nonrecourse debt (for example, at foreclosure), the excess of the cancelled debt over the adjusted basis of the surrendered property is gain from the disposition of property.
Comm’r, 72 T.C. 780, 792 (1979), aff’d 634 F.2d 12 (1980) (a “nonrecourse mortgage debt is a debt of the property owner since he is, in reality, a quasi-obligor on the debt, notwithstanding the fact that the debt is owed by the property.”); Woodsam Associates, Inc. v.
  More results at FactBites »

 
 

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