Magazine article The CPA Journal

Real Estate Workouts - Problems and Opportunities for the CPA

Magazine article The CPA Journal

Real Estate Workouts - Problems and Opportunities for the CPA

Article excerpt

The declining real estate market of the 1990s presents a unique opportunity for CPAs to offer business advice and provide accounting services to clients facing real estate foreclosure. The authors offer a comprehensive review of what is happening in real estate workouts and where CPAs fit in. A practice opportunity to explore.

Real estate markets in the U.S. are now confronted with great uncertainty and an abundance of work-out situations. The current soft estate market is the result of many including: the Resolution Trust Corporation's (RTC) method of disposing of the various parcels, of real estate entrusted to it, the current Crisis in the insurance industry, a weak economy in many geographic areas, a decline in tax incentives for real estate owners, and lower expectations for future real estate values.

These factors have been exacerbated by the intricate financial transactions used and heavy debts incurred (leverage) by syndicators and others to purchase real estate.

Many people are learning that leverage is a two-way street increasing the return on investments when times are good and creating disaster when times are bad. In the 1980s, real estate prices were bid up to unrealistic heights using substantial leverage. The result is that debt service requirements coupled with decreased cash flows from poor operations are forcing holders to sell real estate in order to survive.

Most people in the U.S. have some stake in the real estate market--whether it is because of their own home, other direct investments in real estate, investment through their retirement plans, or, indirectly, through an employer's ownership or obligation related to real estate. The increase in real estate values in the 1980s helped fuel substantial new development and rehabilitation activities in many geographic regions.

Many people began to view real estate as a liquid asset, readily marketable, easily transferred, and offering substantial returns for short periods of ownership. What investors and asset managers have discovered in the early 1990s is that these assets whether held directly or indirectly, are not as liquid or as marketable as previously believed. Consequently, many real estate investments have boomeranged. No matter how much the owner wants to sell, he or she may be forced to continue to fund operating and financing deficits if for no other reason than to delay negative tax consequences. The forgiveness of a debt will result in taxable income for an owner who may not have sufficient cash flow to pay taxes. Also, current federal tax laws and regulations that impose limitations on deductibility of passive activity losses have not improved the real estate market; in fact, they are probably contributing negatively.

Former owners who financed a portion of the sales price may find themselves owners again, by default. The greater the leverage the more severe the problem. It should be remembered that any transfer of real estate, even at a loss, may be subject to state and local real estate transfer taxes.

Given the difficult times and daily news of many well known developers in financial difficulty, an investment in real estate requires careful attention and good advice. This is especially true for properties where current cash flow from operations cannot cover the operating expenses and debt-service payments. Even if the owner is able to fund these deficits, few would be willing to do so for an unlimited time. The resulting workout situations can yield CPAs significant opportunities for demonstrating business acumen and providing value added services to clients.

IS THE CLIENT IN TROUBLE?

How can the CPA for a real estate venture identify potential problems at any stage in its life cycle? The accountant may wish to do this as an advisory service to the client. On the other hand, if the CPA is serving as auditor, he or she may want to do this as part of going concern considerations. …

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