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Nashua, NH-There’s plenty of doom-and-gloom out there, and with declining values, frozen credit markets and tenant bankruptcies, the net lease property sector isn’t immune to the kinds of problems that are just beginning to emerge in the commercial property market. But experts in net lease properties and 1031 exchanges say there may be ways to soften the blow of distressed situations, including the tax consequences of foreclosures.

The advisory group of Net Lease Capital Advisors, for example, has past experience structuring exchanges for investors who face losing a property to foreclosure in such a way that both minimizes their tax bill and puts them in a new investment. If an owner is proactive in pursuing such a strategy before they are foreclosed on, says Carl Christensen, managing director of the Nashua, NH-based company, they can deed their property back to their lender through a qualified intermediary and do a 1031 exchange into a new investment.

The company has access to a significant amount of potential replacement triple-net properties that are primarily leased to investment-grade tenants and typically highly leveraged, says Christensen. Though it depends on the financial and tax particulars of each case, putting equity into the new investment can be considerably less costly than paying the capital gains–which, since a foreclosure is considered a sale, includes the discharge of debt above the owner’s basis–and depreciation recapture tax bill, he adds.

“They’re facing a 20% to 25% tax problem. But you can solve that problem for 7% to 13% [equity] and have the benefit of owning your own real estate and saving money,” says Christensen. “The downside is they have to come out of pocket for the cash, because there is no equity in the property in this particular scenario, but what they have to come out of pocket for to buy the replacement property is significantly less than what they’d have to come out of pocket for to pay the IRS.”

In addition to foreclosures, the strategy could also be applicable to forced-sale situations, when owners can’t put additional equity into a property when refinancing (at today’s lower leverage standards) is necessary and thus are forced to sell at a lower price than what they paid for the property.

“Those folks will have a little bit of equity, they won’t be totally upside down,” says Christensen. “This kind of solution is beautiful for them, because they won’t have to dump more money in to preserve their tax position.”

Net Lease Capital Advisors isn’t alone in identifying opportunities to help distressed property owners make the most of less-than-ideal situations. The net lease investment group of BRC Advisors in Los Angeles has been working on a new platform that also will provide investment-grade, highly leveraged assets as replacement properties for owners facing foreclosure to exchange into.

And Reston, VA-based Calkain Cos. last month launched a new division, Calkain Opportunity Services, to address the needs of a variety of challenged situations, such as potential debt restructurings and failed investments. Todd Harrison was recruited to head up the new division as managing director.

Despite difficult situations such as foreclosures, there are options that can help, concurs Calkain president and CEO Jonathan Hipp. “The last thing you want to do is not be smart about your options. Don’t just assume that you’re dead in the water,” he says. “It’s about good tax planning and trying to be ahead of the bus.”

James Brennan, who recently started his own qualified intermediary company, ES Group LLC, agrees that structuring a new investment to mitigate the damages of a foreclosure is “a great strategy.” Brennan, principal and corporate counsel of the Reston, VA-based QI, adds, “It’s a unique positioning of 1031, it’s a unique use of it.”

So far there the market hasn’t seen a full onslaught of foreclosures in the commercial property space–yet. But Net Lease Capital Advisors’ Christensen sees it coming, and expects to be putting to use the company’s tax-saving strategies more and more. “The demand is picking up,” he says. “We expect that we’re probably going to do quite a bit coming up. It’s really sad.”

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