Commercial and investment property owners who are facing problems refinancing mortgages because of credit market conditions and declining lease revenues may have just gotten some important help from the IRS.

In a policy change outlined last week, the IRS said it is aware that the global capital squeeze is hurting investors who own income real estate and are finding it difficult to stay current on loan payments.

To help ease the burden, the IRS said it would relax current tax guidelines on commercial mortgage bond securitizations to allow more modifications of loan terms.

Commercial real estate, including multifamily apartment projects, has been struggling for the past year.

According to the Mortgage Bankers Association, more building owners are falling behind on payments and seeing property valuations decline as the result of the recession. Between the second and third quarters of this year, the delinquency rate on loans held in commercial mortgage backed securities more than doubled, from 1.9 percent to 3.9 percent.

In its policy change, the IRS noted its tax rules governing commercial property bonds allow for certain levels of loan modifications within loan pools in cases of financial distress and imminent default by borrowers. These modifications include interest rate reductions, extensions of loan terms, and forgiveness of principal debt.

But because IRS's technical rules clamp certain limits on the extent of modifications in a given loan pool, one or more "significant" modifications can terminate the special tax benefits that are crucial ingredients in commercial securitizations.

For certain types of bonds, there is even a 100 percent tax on all net income that is derived from "prohibited transactions."

To permit greater numbers of modifications to occur without triggering prohibited transactions penalties, the IRS said it will lighten up on its rules and not challenge commercial mortgage bonds' tax status in some cases where there is a significant risk of default by borrowers.

Though the IRS's approach is intended to open the door to more modifications for investment property owners in need of relief, mortgage servicing experts were cautious in their initial reactions last week. Jan Sternin, senior vice president of the Mortgage Bankers Association for commercial financing, said that because of the complexity of commercial bond structures, "it will take some time for servicers to determine how much latitude they have to implement the new IRS rules."

Bottom line for income property owners facing loan problems: Get in touch with your mortgage servicer sooner rather than later. Do not assume that a loan modification or refi is out of the question.

In fact, there may be more room for negotiations than ever before.

Published: September 18, 2009

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Kenneth R. Harney writes an award-winning, nationally-syndicated column on housing and real estate from Washington, D.C. He is also managing director of the National Real Estate Development Center, a professional education company. He is a past member of the Federal Reserve Board's Consumer Advisory Council, a committee that by federal statute reviews all Fed actions on home mortgage, consumer credit and banking industry regulation. He served as a member of the U.S. Department of Housing and Urban Development's Working Group on Computerized Loan Origination (CLO) systems, and is a member of the Editorial Board of the Fannie Mae Foundation's journal, Housing Policy Debate. He is the author of two books on mortgage finance and real estate.