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In the current market, many real estate owners continue to struggle as the maturity date approaches for loans on distressed real estate. In one common workout scenario, the lender contributes all or a portion of the outstanding debt to the borrower in exchange for an equity interest in the property. On its face, this transaction might appear to be a simple tax-free contribution to a partnership in exchange for a partnership interest. Unfortunately, this transaction is far from simple, and in many cases will not be tax free. In November, the Internal Revenue Service issued final regulations that provide guidance on (1) the determination of cancellation of indebtedness income of a partnership borrower that issues a partnership interest to its lender in satisfaction of the partnership’s debt, and (2) the tax consequences to the lender. These regulations substantially incorporate proposed regulations issued in 2008, with some helpful modifications, and clarify the tax treatment of this common transaction.

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