Defeasance

The term comes from the REMIC rules that govern securitized loans.

Reg. section 1.860G-2(a)(8) says a mortgage stops being a qualified mortgage in a REMIC if the lien is released, unless the mortgage is defeased. The conditions are that the borrower pledges substitute collateral consisting solely of government securities, the loan documents allow the substitution, the release is to facilitate a sale or other customary commercial transaction, and the release is not within two years of the REMIC's startup day.

A CMBS prospectus filed with the SEC in 2025 shows how loan documents put this into practice. The lock-out period ends at least two years after the closing date; the borrower gives at least 30 days written notice, pays accrued interest and costs, and buys non-callable Treasury or other government securities that make payments on or before each due date equal to the scheduled loan payments, including the balloon, through maturity or the start of the open period. In that pool, loans making up 78.2% of the balance permitted defeasance.

The Fannie Mae Multifamily Guide follows the same pattern for multifamily loans whose documents allow it: the borrower assigns the note and substitute collateral to a successor entity under an assignment and assumption agreement, and pays the servicer's costs, including its legal fees.

A hypothetical: why defeasance costs more when rates have fallen.

Hypothetical figures: your loan has a $5,000,000 balance at 6% with five years left. To defease it you must buy securities whose payments equal every remaining loan payment. If Treasury yields for those maturities are below 6%, the securities cost more than $5,000,000, say $5,300,000, and you also pay the servicer's and other third-party costs. If yields are above 6%, the portfolio can cost less than the balance.

Every dollar of that cost comes out of the sale proceeds, so less reaches your qualified intermediary and you may need more replacement debt or cash to stay fully deferred. Run your own numbers with your CPA.

It bites on closing timing and on how the cost is treated in the exchange.

Notice periods and securities purchases have to be scheduled against the purchase contract, so start the defeasance conversation when you list, as the 1031 pre-sale checklist suggests. A buyer who takes over the loan avoids defeasance altogether; see assumable loan.

No regulation or ruling located for this page classifies defeasance cost for exchange purposes. It is not among the transactional items listed in Reg. section 1.1031(k)-1(g)(7)(ii), and because the loan is not repaid it is not a prepayment premium in form. Agree the treatment with your CPA before closing; the comparison with a prepayment premium is in yield maintenance.