Entnote/24″/dt1st/mark2nd By DAVID ZASLOW and BARRY GLASER With lending rates at a 12-year low, many homeowners have been refinancing their mortgages. As an owner of commercial real estate, you have the same option available to you although you would be well advised to take a good look before you plunge in. Why consider refinancing a piece of commercial property? As with many homeowners, you simply might want to avail yourself of a better interest rate than you got when you purchased the property. Or you might have a substantial amount of equity in the property and need cash right away. A note might be coming due, for example, or you might require cash because you’re in the process of dissolving a partnership or acquiring additional property. Family dynamics are another reason you might refinance commercial real estate especially if you want to transfer the property to, say, your children. Some would rather have cold, hard cash, while others would rather have the real estate. By refinancing the property, you can make everyone happy. Refinancing commercial real estate may sound like a terrific idea, and in many cases it can be, but there are potential pitfalls as well, so it’s vital to carefully weigh the costs and risks against the benefits. When it comes to refinancing commercial properties, there can be some heavy-duty expenses involved, such as fees for document preparation, appraisals, title policy, recording, and tax services, along with the points associated with the loan itself. These costs must be factored into the equation. Perhaps the greatest downside to refinancing is that it can put you and your financial assets at increased risk. In California, lenders can come after your personal assets if you don’t keep up with payments on the refinanced loan. That’s because most lenders will make you sign a personal loan guarantee. One important piece of advice: Whenever possible, avoid “cross-collateralizing.” Simply put, if you have two pieces of commercial real estate, one bad and one good, don’t use the good piece as all or part of the collateral for refinancing the other. If you do and later default on the loan, your creditors will be able to take the good property from you. It’s also extremely important to consider the tax ramifications of any commercial refinancing. Many people refinance a piece of commercial real estate to avoid having to sell it and pay tax now. In many cases, you can refinance the property and have more cash proceeds available than if you sold the property and paid tax. It’s called having your cake and eating it, too. However, refinancing might not guarantee the best tax benefits. If you have excess money after the refinancing, be careful. The interest you pay on the excess proceeds will only be deductible if you can trace these funds to new investment property. Unless you can specifically “track” the excess money to an investment type of asset, the government will consider the interest on that portion of the refinance loan to be consumer debt and you will not be able to deduct the interest. Alternatively, if you decide to sell the property instead of refinancing it, examine your personal situation carefully. Some property owners have assumed they’ll benefit from the new low capital gains rate of 20 percent. However, depending on the circumstances, the Alternative Minimum Tax could kick in and you could wind up paying 28 percent the former maximum capital gains rate. In this situation, you might want to consider a tax-free exchange in order to defer paying taxes. In addition to tax ramifications, there are a number of important issues involved in the loan itself, such as choosing the right lending institution. You could obtain the loan from a bank, a mortgage broker or a savings and loan, to name just three possibilities. The best option depends on the size of the loan. It’s important to be aware of and explore your options. Another issue is deciding what kind of loan you should get. There are different types available, including fixed loans and variable-rate loans. If you’re leaning toward a variable-rate loan, make sure you know what the “cap” is the highest interest rate the loan can reach. Find out the maximum allowable payment increase, and over what timeframe it can occur. Also, ask what type of index the interest rate is tied to. Some indices move slowly; others such as those based on Treasury Bills, CDs or LIBOR (London Interbank Offering Rate) are more volatile. With a slow index, even when interest rates do go up, they’ll rise more slowly than they otherwise would. You need to consider if the loan’s terms are advantageous to you. For instance, are there penalties for paying off the loan early? Or is there a “due on sale” clause, which means a new buyer cannot purchase the property from you and take over the loan without the refinancing lender’s approval? This can be very important later on. Say that eventually, you have 10 years remaining on your loan and want to sell the property. If interest rates have risen and your loan rate is lower than the current rate, it will make selling the property easier but only if you don’t have a “due on sale” clause. It’s something to consider when purchasing or refinancing commercial property. You also need to decide who will take title to the refinanced property. There are a number of possibilities: you, your spouse, your family, a partnership you arrange, etc. Which legal strategy you pursue can have a significant impact on liability issues. Bottom line? To answer the above questions and get a handle on the tax ramifications, speak with your financial advisor before refinancing or selling any piece of commercial real estate. David Zaslow, CPA, is the partner in charge of real estate at the accounting and business consulting firm of Roth Bookstein & Zaslow LLP. Barry Glaser is a partner in the law firm of Resch, Polster, Alpert & Berger LLP. He specializes in real estate, bankruptcy and title litigation. Entrepreneur’s Notebook is a regular column contributed by EC2, The Annenberg Incubator Project, a center for multimedia and electronic communications at the University of Southern California. Contact James Klein at (213) 743-1759 with feedback and topic suggestions.