[Federal Register Volume 60, Number 151 (Monday, August 7, 1995)]
[Rules and Regulations]
[Pages 40086-40092]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 95-19285]
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DEPARTMENT OF THE TREASURY
26 CFR Part 301
[TD 8610]
RIN 1545-AP98
Taxable Mortgage Pools
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Final regulations.
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SUMMARY: This document contains final regulations relating to taxable
mortgage pools. This action is necessary because of changes made to the
law by the Tax Reform Act of 1986. The final regulations provide
guidance to entities for determining whether they are subject to the
taxable mortgage pool rules.
EFFECTIVE DATE: These regulations are effective September 6, 1995.
FOR FURTHER INFORMATION CONTACT: Arnold P. Golub or Marshall D.
Feiring, (202) 622-3950 (not a toll-free number).
SUPPLEMENTARY INFORMATION:
Background
A notice of proposed rulemaking (FI-55-91) under section 7701(i) of
the Internal Revenue Code was published in the Federal Register on
December 23, 1992 (57 FR 61029). Written comments relating to this
notice were received, but no public hearing was requested or held.
After consideration of the comments, the proposed regulations under
section 7701(i) are adopted as revised by this Treasury decision.
Explanation of Provisions
Section 301.7701(i)-1(c)(1)--Basis Used To Determine the Composition of
an Entity's Assets
Among other requirements, to be classified as a taxable mortgage
pool, substantially all of an entity's assets must consist of debt
obligations, and more than 50 percent of those debt obligations must
consist of real estate mortgages (or interests therein). Under the
proposed regulations, an entity must apply these tests using the tax
bases of its assets. One commentator, however, suggested that the
entity should have the choice of using either the tax bases of its
assets or the fair market value of its assets. The IRS and Treasury
believe that using fair market value for the asset composition tests
creates uncertainty and administrative difficulties. The final
regulations, therefore, retain the rule in the proposed regulations.
Section 301.7701(i)-1(c)(5)--Seriously Impaired Real Estate Mortgages
Not Treated as Debt Obligations
Under the proposed regulations, real estate mortgages that are
seriously impaired are not treated as debt obligations for purposes of
the asset composition tests. Whether real estate mortgages are
seriously impaired generally depends on all the facts and
circumstances. The proposed regulations, however, provide two safe
harbors. Under those provisions, whether mortgages are seriously
impaired depends only on the number of days the payments on the
mortgages are delinquent (more than 89 days for single family
residential real estate mortgages and more than 59 days for multi-
family residential and commercial real estate mortgages). The safe
harbors are not available, however, if an entity is receiving or
anticipates receiving certain payments on the mortgages such as
payments of principal and interest that are substantial and relatively
certain as to amount.
Several commentators have asked for additional safe harbors based
on factors other than the number of days a mortgage is delinquent. For
example, one suggested a safe harbor for mortgages having excessively
high loan to value ratios. Others suggested a safe harbor for mortgages
that are purchased at a substantial discount.
The final regulations retain, unchanged, the safe harbors of the
proposed regulations. The IRS and Treasury believe that no single
factor is as clear an indication that a mortgage is seriously impaired
as days delinquent. For example, a mortgage may be purchased at a
discount for a variety of reasons, some of which bear no relation to
the quality of the mortgage. To provide further guidance, however, the
final regulations list some of the facts and circumstances that should
be considered in determining whether a mortgage is seriously impaired.
Another commentator has criticized the safe harbors because they
are unavailable if an entity anticipates receiving certain payments on
a delinquent mortgage. The commentator is concerned that a test based
on whether an entity anticipates receiving payments on a mortgage is
both subjective and open-ended. To address this concern, the final
regulations create a new rule, under which if an entity makes
reasonable efforts to resolve a
[[Page 40087]]
mortgage and fails to do so within a designated time, then the entity
is treated as not having anticipated receiving payments on the
mortgage.
Section 301.7701(i)-1(d)(3)(ii)--Obligations Secured by Other
Obligations Treated as Principally Secured by Real Property
Under the proposed regulations, an obligation is treated as a real
estate mortgage if it is principally secured by an interest in real
property. Whether an obligation is principally secured by an interest
in real property ordinarily depends on the value of the real property
relative to the amount of the obligation. The proposed regulations also
provide that an obligation secured by real estate mortgages is treated
as an obligation secured by an interest in real property. That
obligation, therefore, may itself qualify as a real estate mortgage.
The final regulations retain these rules and clarify how they are
applied if an obligation is secured by both real estate mortgages and
other property. Under the final regulations, such an obligation is
treated as secured by real property, but only to the extent of the
combined value of the real estate mortgages and any real property that
secures the obligation.
Section 301.7701(i)-1(f)(3)--Certain Liquidating Entities Not Treated
as Taxable Mortgage Pools
The proposed regulations provide that an entity formed to liquidate
real estate mortgages is not treated as a taxable mortgage pool if the
entity meets four conditions. One condition is that the entity must
liquidate within three years of acquiring its first asset. If the
entity fails to liquidate within that time, then the payments the
entity receives on its assets must be paid through to the holders of
the entity's liabilities in proportion to the adjusted issue prices of
the liabilities.
One commentator has asked that this condition be modified. The
commentator suggested that either the three- year liquidation period
should be extended to four years or an entity should have to liquidate
only a certain percentage of its assets within the three-year period.
The commentator alternatively suggested that an entity should be
treated as meeting the condition if it satisfies fifty percent of the
issue price of each of its liabilities using liquidation proceeds.
The final regulations retain the three-year liquidation rule. The
IRS and Treasury believe that performing mortgages that conform to
current underwriting standards may easily be disposed of within that
time. Further, the market has developed to the point where three years
is also ample time to dispose of non-performing mortgages. Mortgages
that require more than three years for disposal are more likely to be
seriously impaired, and a taxpayer who holds a sufficient quantity can
avoid taxable mortgage pool classification by other means. The final
regulations, therefore, do not change the basic rules in the proposed
regulations.
Section 301.7701-1(g)--Anti-Avoidance Rules
An anti-avoidance rule in the proposed regulations authorizes the
Commissioner to disregard or make other adjustments to any transaction
if the transaction is entered into with a view to achieving the same
economic effect as that of an arrangement subject to section 7701(i)
while avoiding the application of that section. This authority is
flexible, and among other things, includes the ability to override any
safe harbor otherwise available under the regulations. The final
regulations retain the anti-avoidance rule and provide two additional
examples illustrating its exercise.
Section 301.7701(i)-4--Certain Governmental Entities Not Treated as
Taxable Mortgage Pools
The proposed regulations provide that an entity is not classified
as a taxable mortgage pool if: (1) The entity issuing the debt
obligations is a State, the District of Columbia, or a political
subdivision within the meaning of Sec. 1.103-1(b), or is empowered to
issue obligations on behalf of one of the foregoing; (2) the entity
issues the debt obligations in the performance of a governmental
purpose; and (3) the entity holds the remaining interest in any asset
that supports the outstanding debt obligations until those obligations
are satisfied.
Two commentators have asked that the third requirement be dropped
because it prevents a governmental entity from reselling a package of
mortgages. The IRS and Treasury believe, however, that dropping the
requirement is inappropriate. Typically, when a mortgage pool is used
to create multiple class debt, tax gains in excess of economic gains
are generated during the early part of the pool's life and tax losses
in excess of economic losses are generated during the latter part of
the pool's life. Without the third requirement, a governmental entity
can hold an interest in the pool during the early period and then
convey that interest to a taxable entity during the latter period.
Moreover, requiring a governmental entity to maintain an interest in
pool assets is consistent with the second requirement that debt
obligations supported by the pool are issued in performance of a
governmental purpose.
Special Analyses
It has been determined that this Treasury decision is not a
significant regulatory action as defined in EO 12866. Therefore, a
regulatory assessment is not required. It also has been determined that
section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5)
and the Regulatory Flexibility Act (5 U.S.C. chapter 6) do not apply to
these regulations, and, therefore, a Regulatory Flexibility Analysis is
not required. Pursuant to section 7805(f) of the Internal Revenue Code,
the notice of proposed rulemaking preceding these regulations was
submitted to the Small Business Administration for comment on its
impact on small business.
Drafting Information
The principal authors of these regulations are Marshall D. Feiring
and Arnold P. Golub, Office of Assistant Chief Counsel (Financial
Institutions and Products), and Carol E. Schultze, formerly of that
office. However, other personnel from the IRS and Treasury Department
participated in their development.
The Office of Assistant Chief Counsel (Financial Institutions and
Products) notes with sadness the passing of Susan E. Overlander, who
contributed significantly to this project.
List of Subjects in 26 CFR Part 301
Employment taxes, Estate taxes, Excise taxes, Gift taxes, Income
taxes, Penalties, Reporting and recordkeeping requirements.
Adoption of Amendments to the Regulations
Accordingly, 26 CFR part 301 is amended as follows:
PART 301--PROCEDURE AND ADMINISTRATION
Paragraph 1. The authority citation for part 301 is amended by
adding the following citations in numerical order to read as follows:
Authority: 26 U.S.C. 7805 * * *
Section 301.7701(i)-1(g)(1) also issued under 26 U.S.C.
7701(i)(2)(D).
Section 301.7701(i)-4(b) also issued under 26 U.S.C. 7701(i)(3).
* * *
Par. 2. Sections 301.7701(i)-0 through 301.7701(i)-4 are added to
read as follows:
[[Page 40088]]
Sec. 301.7701(i)-0 Outline of taxable mortgage pool provisions.
This section lists the major paragraphs contained in
Secs. 301.7701(i)-1 through 301.7701(i)-4.
Sec. 301.7701(i)-1 Definition of a taxable mortgage pool.
(a) Purpose.
(b) In general.
(c) Asset composition tests.
(1) Determination of amount of assets.
(2) Substantially all.
(i) In general.
(ii) Safe harbor.
(3) Equity interests in pass-through arrangements.
(4) Treatment of certain credit enhancement contracts.
(i) In general.
(ii) Credit enhancement contract defined.
(5) Certain assets not treated as debt obligations.
(i) In general.
(ii) Safe harbor.
(A) In general.
(B) Payments with respect to a mortgage defined.
(C) Entity treated as not anticipating payments.
(d) Real estate mortgages or interests therein defined.
(1) In general.
(2) Interests in real property and real property defined.
(i) In general.
(ii) Manufactured housing.
(3) Principally secured by an interest in real property.
(i) Tests for determining whether an obligation is principally
secured.
(A) The 80 percent test.
(B) Alternative test.
(ii) Obligations secured by real estate mortgages (or interests
therein), or by combinations of real estate mortgages (or interests
therein) and other assets.
(A) In general.
(B) Example.
(e) Two or more maturities.
(1) In general.
(2) Obligations that are allocated credit risk unequally.
(3) Examples.
(f) Relationship test.
(1) In general.
(2) Payments on asset obligations defined.
(3) Safe harbor for entities formed to liquidate assets.
(g) Anti-avoidance rules.
(1) In general.
(2) Certain investment trusts.
(3) Examples.
Sec. 301.7701(i)-2 Special rules for portions of entities.
(a) Portion defined.
(b) Certain assets and rights to assets disregarded.
(1) Credit enhancement assets.
(2) Assets unlikely to service obligations.
(3) Recourse.
(c) Portion as obligor.
(1) In general.
(2) Example.
Sec. 301.7701(i)-3 Effective dates and duration of taxable
mortgage pool classification.
(a) Effective dates.
(b) Entities in existence on December 31, 1991.
(1) In general.
(2) Special rule for certain transfers.
(3) Related debt obligation.
(4) Example.
(c) Duration of taxable mortgage pool classification.
(1) Commencement and duration.
(2) Testing day defined.
Sec. 301.7701(i)-4 Special rules for certain entities.
(a) States and municipalities.
(1) In general.
(2) Governmental purpose.
(3) Determinations by the Commissioner.
(b) REITs. [Reserved]
(c) Subchapter S corporations.
(1) In general.
(2) Portion of an S corporation treated as a separate
corporation.
Sec. 301.7701(i)-1 Definition of a taxable mortgage pool.
(a) Purpose. This section provides rules for applying section
7701(i), which defines taxable mortgage pools. The purpose of section
7701(i) is to prevent income generated by a pool of real estate
mortgages from escaping Federal income taxation when the pool is used
to issue multiple class mortgage-backed securities. The regulations in
this section and in Secs. 301.7701(i)-2 through 301.7701(i)-4 are to be
applied in accordance with this purpose. The taxable mortgage pool
provisions apply to entities or portions of entities that qualify for
REMIC status but do not elect to be taxed as REMICs as well as to
certain entities or portions of entities that do not qualify for REMIC
status.
(b) In general. (1) A taxable mortgage pool is any entity or
portion of an entity (as defined in Sec. 301.7701(i)-2) that satisfies
the requirements of section 7701(i)(2)(A) and this section as of any
testing day (as defined in Sec. 301.7701(i)-3(c)(2)). An entity or
portion of an entity satisfies the requirements of section
7701(i)(2)(A) and this section if substantially all of its assets are
debt obligations, more than 50 percent of those debt obligations are
real estate mortgages, the entity is the obligor under debt obligations
with two or more maturities, and payments on the debt obligations under
which the entity is obligor bear a relationship to payments on the debt
obligations that the entity holds as assets.
(2) Paragraph (c) of this section provides the tests for
determining whether substantially all of an entity's assets are debt
obligations and for determining whether more than 50 percent of its
debt obligations are real estate mortgages. Paragraph (d) of this
section defines real estate mortgages for purposes of the 50 percent
test. Paragraph (e) of this section defines two or more maturities and
paragraph (f) of this section provides rules for determining whether
debt obligations bear a relationship to the assets held by an entity.
Paragraph (g) of this section provides anti-avoidance rules. Section
301.7701(i)-2 provides rules for applying section 7701(i) to portions
of entities and Sec. 301.7701(i)-3 provides effective dates. Section
301.7701(i)-4 provides special rules for certain entities. For purposes
of the regulations under section 7701(i), the term entity includes a
portion of an entity (within the meaning of section 7701(i)(2)(B)),
unless the context clearly indicates otherwise.
(c) Asset composition tests--(1) Determination of amount of assets.
An entity must use the Federal income tax basis of an asset for
purposes of determining whether substantially all of its assets consist
of debt obligations (or interests therein) and whether more than 50
percent of those debt obligations (or interests) consist of real estate
mortgages (or interests therein). For purposes of this paragraph, an
entity determines the basis of an asset with the assumption that the
entity is not a taxable mortgage pool.
(2) Substantially all--(i) In general. Whether substantially all of
the assets of an entity consist of debt obligations (or interests
therein) is based on all the facts and circumstances.
(ii) Safe harbor. Notwithstanding paragraph (c)(2)(i) of this
section, if less than 80 percent of the assets of an entity consist of
debt obligations (or interests therein), then less than substantially
all of the assets of the entity consist of debt obligations (or
interests therein).
(3) Equity interests in pass-through arrangements. The equity
interest of an entity in a partnership, S corporation, trust, REIT, or
other pass-through arrangement is deemed to have the same composition
as the entity's share of the assets of the pass-through arrangement.
For example, if an entity's stock interest in a REIT has an adjusted
basis of $20,000, and the assets of the REIT consist of equal portions
of real estate mortgages and other real estate assets, then the entity
is treated as holding $10,000 of real estate mortgages and $10,000 of
other real estate assets.
(4) Treatment of certain credit enhancement contracts--(i) In
general. A credit enhancement contract (as defined in paragraph
(c)(4)(ii) of this section) is not treated as a separate asset of an
entity for purposes of the asset composition tests set forth in section
[[Page 40089]]
7701(i)(2)(A)(i), but instead is treated as part of the asset to which
it relates. Furthermore, any collateral supporting a credit enhancement
contract is not treated as an asset of an entity solely because it
supports the guarantee represented by that contract.
(ii) Credit enhancement contract defined. For purposes of this
section, a credit enhancement contract is any arrangement whereby a
person agrees to guarantee full or partial payment of the principal or
interest payable on a debt obligation (or interest therein) or on a
pool of such obligations (or interests), or full or partial payment on
one or more classes of debt obligations under which an entity is the
obligor, in the event of defaults or delinquencies on debt obligations,
unanticipated losses or expenses incurred by the entity, or lower than
expected returns on investments. Types of credit enhancement contracts
may include, but are not limited to, pool insurance contracts,
certificate guarantee insurance contracts, letters of credit,
guarantees, or agreements whereby an entity, a mortgage servicer, or
other third party agrees to make advances (regardless of whether, under
the terms of the agreement, the payor is obligated, or merely
permitted, to make those advances). An agreement by a debt servicer to
advance to an entity out of its own funds an amount to make up for
delinquent payments on debt obligations is a credit enhancement
contract. An agreement by a debt servicer to pay taxes and hazard
insurance premiums on property securing a debt obligation, or other
expenses incurred to protect an entity's security interests in the
collateral in the event that the debtor fails to pay such taxes,
insurance premium, or other expenses, is a credit enhancement contract.
(5) Certain assets not treated as debt obligations--(i) In general.
For purposes of section 7701(i)(2)(A), real estate mortgages that are
seriously impaired are not treated as debt obligations. Whether a
mortgage is seriously impaired is based on all the facts and
circumstances including, but not limited to: the number of days
delinquent, the loan-to-value ratio, the debt service coverage (based
upon the operating income from the property), and the debtor's
financial position and stake in the property. However, except as
provided in paragraph (c)(5)(ii) of this section, no single factor in
and of itself is determinative of whether a loan is seriously impaired.
(ii) Safe harbor--(A) In general. Unless an entity is receiving or
anticipates receiving payments with respect to a mortgage, a single
family residential real estate mortgage is seriously impaired if
payments on the mortgage are more than 89 days delinquent, and a multi-
family residential or commercial real estate mortgage is seriously
impaired if payments on the mortgage are more than 59 days delinquent.
Whether an entity anticipates receiving payments with respect to a
mortgage is based on all the facts and circumstances.
(B) Payments with respect to a mortgage defined. For purposes of
paragraph (c)(5)(ii)(A) of this section, payments with respect to a
mortgage mean any payments on the mortgage as defined in paragraph
(f)(2)(i) of this section if those payments are substantial and
relatively certain as to amount and any payments on the mortgage as
defined in paragraph (f)(2) (ii) or (iii) of this section.
(C) Entity treated as not anticipating payments. With respect to
any testing day (as defined in Sec. 301.7701(i)-3(c)(2)), an entity is
treated as not having anticipated receiving payments on the mortgage as
defined in paragraph (f)(2)(i) of this section if 180 days after the
testing day, and despite making reasonable efforts to resolve the
mortgage, the entity is not receiving such payments and has not entered
into any agreement to receive such payments.
(d) Real estate mortgages or interests therein defined--(1) In
general. For purposes of section 7701(i)(2)(A)(i), the term real estate
mortgages (or interests therein) includes all--
(i) Obligations (including participations or certificates of
beneficial ownership therein) that are principally secured by an
interest in real property (as defined in paragraph (d)(3) of this
section);
(ii) Regular and residual interests in a REMIC; and
(iii) Stripped bonds and stripped coupons (as defined in section
1286(e) (2) and (3)) if the bonds (as defined in section 1286(e)(1))
from which such stripped bonds or stripped coupons arose would have
qualified as real estate mortgages or interests therein.
(2) Interests in real property and real property defined--(i) In
general. The definition of interests in real property set forth in
Sec. 1.856-3(c) of this chapter and the definition of real property set
forth in Sec. 1.856-3(d) of this chapter apply to define those terms
for purposes of paragraph (d) of this section.
(ii) Manufactured housing. For purposes of this section, the
definition of real property includes manufactured housing, provided the
properties qualify as single family residences under section 25(e)(10)
and without regard to the treatment of the properties under state law.
(3) Principally secured by an interest in real property--(i) Tests
for determining whether an obligation is principally secured. For
purposes of paragraph (d)(1) of this section, an obligation is
principally secured by an interest in real property only if it
satisfies either the test set out in paragraph (d)(3)(i)(A) of this
section or the test set out in paragraph (d)(3)(i)(B) of this section.
(A) The 80 percent test. An obligation is principally secured by an
interest in real property if the fair market value of the interest in
real property (as defined in paragraph (d)(2) of this section) securing
the obligation was at least equal to 80 percent of the adjusted issue
price of the obligation at the time the obligation was originated (that
is, the issue date). For purposes of this test, the fair market value
of the real property interest is first reduced by the amount of any
lien on the real property interest that is senior to the obligation
being tested, and is reduced further by a proportionate amount of any
lien that is in parity with the obligation being tested.
(B) Alternative test. An obligation is principally secured by an
interest in real property if substantially all of the proceeds of the
obligation were used to acquire, improve, or protect an interest in
real property that, at the origination date, is the only security for
the obligation. For purposes of this test, loan guarantees made by
Federal, state, local governments or agencies, or other third party
credit enhancement, are not viewed as additional security for a loan.
An obligation is not considered to be secured by property other than
real property solely because the obligor is personally liable on the
obligation.
(ii) Obligations secured by real estate mortgages (or interests
therein), or by combinations of real estate mortgages (or interests
therein) and other assets--(A) In general. An obligation secured only
by real estate mortgages (or interests therein), as defined in
paragraph (d)(1) of this section, is treated as an obligation secured
by an interest in real property to the extent of the value of the real
estate mortgages (or interests therein). An obligation secured by both
real estate mortgages (or interests therein) and other assets is
treated as an obligation secured by an interest in real property to the
extent of both the value of the real estate mortgages (or interests
therein) and the value of so much of the other assets that constitute
real property. Thus, under this paragraph, a collateralized mortgage
[[Page 40090]]
obligation may be an obligation principally secured by an interest in
real property. This section is applicable only to obligations issued
after December 31, 1991.
(B) Example. The following example illustrates the principles of
this paragraph (d)(3)(ii):
Example. At the time it is originated, an obligation has an
adjusted issue price of $300,000 and is secured by a $70,000 loan
principally secured by an interest in a single family home, a fifty
percent co-ownership interest in a $400,000 parcel of land, and
$80,000 of stock. Under paragraph (d)(3)(ii)(A) of this section, the
obligation is treated as secured by interests in real property and
under paragraph (d)(3)(i)(A) of this section, the obligation is
treated as principally secured by interests in real property.
(e) Two or more maturities--(1) In general. For purposes of section
7701(i)(2)(A)(ii), debt obligations have two or more maturities if they
have different stated maturities or if the holders of the obligations
possess different rights concerning the acceleration of or delay in the
maturities of the obligations.
(2) Obligations that are allocated credit risk unequally. Debt
obligations that are allocated credit risk unequally do not have, by
that reason alone, two or more maturities. Credit risk is the risk that
payments of principal or interest will be reduced or delayed because of
a default on an asset that supports the debt obligations.
(3) Examples. The following examples illustrate the principles of
this paragraph (e):
Example 1. (i) Corporation M transfers a pool of real estate
mortgages to a trustee in exchange for Class A bonds and a
certificate representing the residual beneficial ownership of the
pool. All Class A bonds have a stated maturity of March 1, 2002, but
if cash flows from the real estate mortgages and investments are
sufficient, the trustee may select one or more bonds at random and
redeem them earlier.
(ii) The Class A bonds do not have different maturities. Each
outstanding Class A bond has an equal chance of being redeemed
because the selection process is random. The holders of the Class A
bonds, therefore, have identical rights concerning the maturities of
their obligations.
Example 2. (i) Corporation N transfers a pool of real estate
mortgages to a trustee in exchange for Class C bonds, Class D bonds,
and a certificate representing the residual beneficial ownership of
the pool. The Class D bonds are subordinate to the Class C bonds so
that cash flow shortfalls due to defaults or delinquencies on the
real estate mortgages are borne first by the Class D bond holders.
The terms of the bonds are otherwise identical in all relevant
aspects except that the Class D bonds carry a higher coupon rate
because of the subordination feature.
(ii) The Class C bonds and the Class D bonds share credit risk
unequally because of the subordination feature. However, neither
this difference, nor the difference in interest rates, causes the
bonds to have different maturities. The result is the same if, in
addition to the other terms described in paragraph (i) of this
Example 2, the Class C bonds are accelerated as a result of the
issuer becoming unable to make payments on the Class C bonds as they
become due.
(f) Relationship test--(1) In general. For purposes of section
7701(i)(2)(A)(iii), payments on debt obligations under which an entity
is the obligor (liability obligations) bear a relationship to payments
(as defined in paragraph (f)(2) of this section) on debt obligations an
entity holds as assets (asset obligations) if under the terms of the
liability obligations (or underlying arrangement) the timing and amount
of payments on the liability obligations are in large part determined
by the timing and amount of payments or projected payments on the asset
obligations. For purposes of the relationship test, any payment
arrangement, including a swap or other hedge, that achieves a
substantially similar result is treated as satisfying the test. For
example, any arrangement where the timing and amount of payments on
liability obligations are determined by reference to a group of assets
(or an index or other type of model) that has an expected payment
experience similar to that of the asset obligations is treated as
satisfying the relationship test.
(2) Payments on asset obligations defined. For purposes of section
7701(i)(2)(A)(iii) and this section, payments on asset obligations
include--
(i) A payment of principal or interest on an asset obligation,
including a prepayment of principal, a payment under a credit
enhancement contract (as defined in paragraph (c)(4)(ii) of this
section) and a payment from a settlement at a discount (other than a
substantial discount);
(ii) A payment from a settlement at a substantial discount, but
only if the settlement is arranged, whether in writing or otherwise,
prior to the issuance of the liability obligations; and
(iii) A payment from the foreclosure on or sale of an asset
obligation, but only if the foreclosure or sale is arranged, whether in
writing or otherwise, prior to the issuance of the liability
obligations.
(3) Safe harbor for entities formed to liquidate assets. Payments
on liability obligations of an entity do not bear a relationship to
payments on asset obligations of the entity if--
(i) The entity's organizational documents manifest clearly that the
entity is formed for the primary purpose of liquidating its assets and
distributing proceeds of liquidation;
(ii) The entity's activities are all reasonably necessary to and
consistent with the accomplishment of liquidating assets;
(iii) The entity plans to satisfy at least 50 percent of the total
issue price of each of its liability obligations having a different
maturity with proceeds from liquidation and not with scheduled payments
on its asset obligations; and
(iv) The terms of the entity's liability obligations (or underlying
arrangement) provide that within three years of the time it first
acquires assets to be liquidated the entity either--
(A) Liquidates; or
(B) Begins to pass through without delay all payments it receives
on its asset obligations (less reasonable allowances for expenses) as
principal payments on its liability obligations in proportion to the
adjusted issue prices of the liability obligations.
(g) Anti-avoidance rules--(1) In general. For purposes of
determining whether an entity meets the definition of a taxable
mortgage pool, the Commissioner can disregard or make other adjustments
to a transaction (or series of transactions) if the transaction (or
series) is entered into with a view to achieving the same economic
effect as that of an arrangement subject to section 7701(i) while
avoiding the application of that section. The Commissioner's authority
includes treating equity interests issued by a non-REMIC as debt if the
entity issues equity interests that correspond to maturity classes of
debt.
(2) Certain investment trusts. Notwithstanding paragraph (g)(1) of
this section, an ownership interest in an entity that is classified as
a trust under Sec. 301.7701-4(c) will not be treated as a debt
obligation of the trust.
(3) Examples. The following examples illustrate the principles of
this paragraph (g):
Example 1. (i) Partnership P, in addition to its other
investments, owns $10,000,000 of mortgage pass-through certificates
guaranteed by FNMA (FNMA Certificates). On May 15, 1997, Partnership
P transfers the FNMA Certificates to Trust 1 in exchange for 100
Class A bonds and Certificate 1. The Class A bonds, under which
Trust 1 is the obligor, have a stated principal amount of $5,000,000
and bear a relationship to the FNMA Certificates (within the meaning
of Sec. 301.7701(i)-1(f)). Certificate 1 represents the residual
beneficial ownership of the FNMA Certificates.
(ii) On July 5, 1997, with a view to avoiding the application of
section 7701(i), Partnership P transfers Certificate 1 to Trust 2 in
exchange for 100 Class B bonds and Certificate 2. The Class B bonds,
under which
[[Page 40091]]
Trust 2 is the obligor, have a stated principal amount of $5,000,000,
bear a relationship to the FNMA Certificates (within the meaning of
Sec. 301.7701(i)-1(f)), and have a different maturity than the Class
A bonds (within the meaning of Sec. 301.7701(i)-1(e)). Certificate 2
represents the residual beneficial ownership of Certificate 1.
(iii) For purposes of determining whether Trust 1 is classified
as a taxable mortgage pool, the Commissioner can disregard the
separate existence of Trust 2 and treat Trust 1 and Trust 2 as a
single trust.
Example 2. (i) Corporation Q files a consolidated return with
its two wholly-owned subsidiaries, Corporation R and Corporation S.
Corporation R is in the business of building and selling single
family homes. Corporation S is in the business of financing sales of
those homes.
(ii) On August 10, 1998, Corporation S transfers a pool of its
real estate mortgages to Trust 3, taking back Certificate 3 which
represents beneficial ownership of the pool. On September 25, 1998,
with a view to avoiding the application of section 7701(i),
Corporation R issues bonds that have different maturities (within
the meaning of Sec. 301.7701(i)-1(e)) and that bear a relationship
(within the meaning of Sec. 301.7701(i)-1(f)) to the real estate
mortgages in Trust 3. The holders of the bonds have an interest in a
credit enhancement contract that is written by Corporation S and
collateralized with Certificate 3.
(iii) For purposes of determining whether Trust 3 is classified
as a taxable mortgage pool, the Commissioner can treat Trust 3 as
the obligor of the bonds issued by Corporation R.
Example 3. (i) Corporation X, in addition to its other assets,
owns $110,000,000 in Treasury securities. From time to time,
Corporation X acquires pools of real estate mortgages, which it
immediately uses to issue multiple-class debt obligations.
(ii) On October 1, 1996, Corporation X transfers $20,000,000 in
Treasury securities to Trust 4 in exchange for Class C bonds, Class
D bonds, Class E bonds, and Certificate 4. Trust 4 is the obligor of
the bonds. The different classes of bonds have the same stated
maturity date, but if cash flows from the Trust 4 assets exceed the
amounts needed to make interest payments, the trustee uses the
excess to retire the classes of bonds in alphabetical order.
Certificate 4 represents the residual beneficial ownership of the
Treasury securities.
(iii) With a view to avoiding the application of section
7701(i), Corporation X reserves the right to replace any Trust 4
asset with real estate mortgages or guaranteed mortgage pass-through
certificates. In the event the right is exercised, cash flows on the
real estate mortgages and guaranteed pass-through certificates will
be used in the same manner as cash flows on the Treasury securities.
Corporation X exercises this right of replacement on February 1,
1997.
(iv) For purposes of determining whether Trust 4 is classified
as a taxable mortgage pool, the Commissioner can treat February 1,
1997, as a testing day (within the meaning of Sec. 301.7701(i)-
3(c)(2)). The result is the same if Corporation X has an obligation,
rather than a right, to replace the Trust 4 assets with real estate
mortgages and guaranteed pass-through certificates.
Example 4. (i) Corporation Y, in addition to its other assets,
owns $1,900,000 in obligations secured by personal property. On
November 1, 1995, Corporation Y begins negotiating a $2,000,000 loan
to individual A. As security for the loan, A offers a first deed of
trust on land worth $1,700,000.
(ii) With a view to avoiding the application of section 7701(i),
Corporation Y induces A to place the land in a partnership in which
A will have a 95 percent interest and agrees to accept the
partnership interest as security for the $2,000,000 loan.
Thereafter, the loan to A, together with the $1,900,000 in
obligations secured by personal property, are transferred to Trust 5
and used to issue bonds that have different maturities (within the
meaning of Sec. 301.7701(i)-1(e)) and that bear a relationship
(within the meaning of Sec. 301.7701(i)-1(f)) to the $1,900,000 in
obligations secured by personal property and the loan to A.
(iii) For purposes of determining whether Trust 5 is a taxable
mortgage pool, the Commissioner can treat the loan to A as an
obligation secured by an interest in real property rather than as an
obligation secured by an interest in a partnership.
Example 5. (i) Corporation Z, in addition to its other assets,
owns $3,000,000 in notes secured by interests in retail shopping
centers. Partnership L, in addition to its other assets, owns
$20,000,000 in notes that are principally secured by interests in
single family homes and $3,500,000 in notes that are principally
secured by interests in personal property.
(ii) On December 1, 1995, Partnership L asks Corporation Z for
two separate loans, one in the amount of $9,375,000 and another in
the amount of $625,000. Partnership L offers to collateralize the
$9,375,000 loan with $10,312,500 of notes secured by interests in
single family homes and the $625,000 loan with $750,000 of notes
secured by interests in personal property. Corporation Z has made
similar loans to Partnership L in the past.
(iii) With a view to avoiding the application of section
7701(i), Corporation Z induces Partnership L to accept a single
$10,000,000 loan and to post as collateral $7,500,000 of the notes
secured by interests in single family homes and all $3,500,000 of
the notes secured by interests in personal property. Ordinarily,
Corporation Z would not make a loan on these terms. Thereafter, the
loan to Partnership L, together with the $3,000,000 in notes secured
by interests in retail shopping centers, are transferred to Trust 6
and used to issue bonds that have different maturities (within the
meaning of Sec. 301.7701(i)-1(e)) and that bear a relationship
(within the meaning of Sec. 301.7701(i)-1(f)) to the loans secured
by interests in retail shopping centers and the loan to Partnership
L.
(iv) For purposes of determining whether Trust 6 is a taxable
mortgage pool, the Commissioner can treat the $10,000,000 loan to
Partnership L as consisting of a $9,375,000 obligation secured by
interests in real property and a $625,000 obligation secured by
interests in personal property. Under Sec. 301.7701(i)-
1(d)(3)(ii)(A), the notes secured by single family homes are treated
as $7,500,000 of interests in real property. Under Sec. 301.7701(i)-
1(d)(3)(i)(A), $7,500,000 of interests in real property are
sufficient to treat the $9,375,000 obligation as principally secured
by an interest in real property ($7,500,000 equals 80 percent of
$9,375,000).
Sec. 301.7701(i)-2 Special rules for portions of entities.
(a) Portion defined. Except as provided in paragraph (b) of this
section and Sec. 301.7701(i)-1, a portion of an entity includes all
assets that support one or more of the same issues of debt obligations.
For this purpose, an asset supports a debt obligation if, under the
terms of the debt obligation (or underlying arrangement), the timing
and amount of payments on the debt obligation are in large part
determined, either directly or indirectly, by the timing and amount of
payments or projected payments on the asset or a group of assets that
includes the asset. Indirect payment arrangements include, for example,
a swap or other hedge, or arrangements where the timing and amount of
payments on the debt obligations are determined by reference to a group
of assets (or an index or other type of model) that has an expected
payment experience similar to that of the assets. For purposes of this
paragraph, the term payments includes all proceeds and receipts from an
asset.
(b) Certain assets and rights to assets disregarded--(1) Credit
enhancement assets. An asset that qualifies as a credit enhancement
contract (as defined in Sec. 301.7701(i)-1(c)(4)(ii)) is not included
in a portion as a separate asset, but is treated as part of the assets
in the portion to which it relates under Sec. 301.7701(i)-1(c)(4)(i).
An asset that does not qualify as a credit enhancement contract (as
defined in Sec. 301.7701(i)-1(c)(4)(ii)), but that nevertheless serves
the same function as a credit enhancement contract, is not included in
a portion as a separate asset or otherwise.
(2) Assets unlikely to service obligations. A portion does not
include assets that are unlikely to produce any significant cash flows
for the holders of the debt obligations. This paragraph applies even if
the holders of the debt obligations are legally entitled to cash flows
from the assets. Thus, for example, even if the sale of a building
would cause a series of debt obligations to be redeemed, the building
is not included in a portion if it is not likely to be sold.
(3) Recourse. An asset is not included in a portion solely because
the holders
[[Page 40092]]
of the debt obligations have recourse to the holder of that asset.
(c) Portion as obligor--(1) In general. For purposes of section
7701(i)(2)(A)(ii), a portion of an entity is treated as the obligor of
all debt obligations supported by the assets in that portion.
(2) Example. The following example illustrates the principles of
this section:
Example. (i) Corporation Z owns $1,000,000,000 in assets
including an office complex and $90,000,000 of real estate
mortgages.
(ii) On November 30, 1998, Corporation Z issues eight classes of
bonds, Class A through Class H. Each class is secured by a separate
letter of credit and by a lien on the office complex. One group of
the real estate mortgages supports Class A through Class D, another
group supports Class E through Class G, and a third group supports
Class H. It is anticipated that the cash flows from each group of
mortgages will service its related bonds.
(iii) Each of the following constitutes a separate portion of
Corporation Z: the group of mortgages supporting Class A through
Class D; the group of mortgages supporting Class E through Class G;
and the group of mortgages supporting Class H. No other asset is
included in any of the three portions notwithstanding the lien of
the bonds on the office complex and the fact that Corporation Z is
the issuer of the bonds. The letters of credit are treated as
incidents of the mortgages to which they relate.
(iv) For purposes of section 7701(i)(2)(A)(ii), each portion
described above is treated as the obligor of the bonds of that
portion, notwithstanding the fact that Corporation Z is the legal
obligor with respect to the bonds.
Sec. 301.7701(i)-3 Effective dates and duration of taxable mortgage
pool classification.
(a) Effective dates. Except as otherwise provided, the regulations
under section 7701(i) are effective and applicable September 6, 1995.
(b) Entities in existence on December 31, 1991--(1) In general. For
transitional rules concerning the application of section 7701(i) to
entities in existence on December 31, 1991, see section 675(c) of the
Tax Reform Act of 1986.
(2) Special rule for certain transfers. A transfer made to an
entity on or after September 6, 1995, is a substantial transfer for
purposes of section 675(c)(2) of the Tax Reform Act of 1986 only if--
(i) The transfer is significant in amount; and
(ii) The transfer is connected to the entity's issuance of related
debt obligations (as defined in paragraph (b)(3) of this section) that
have different maturities (within the meaning of Sec. 301.7701-1(e)).
(3) Related debt obligation. A related debt obligation is a debt
obligation whose payments bear a relationship (within the meaning of
Sec. 301.7701-1(f)) to payments on debt obligations that the entity
holds as assets.
(4) Example. The following example illustrates the principles of
this paragraph (b):
Example. On December 31, 1991, Partnership Q holds a pool of
real estate mortgages that it acquired through retail sales of
single family homes. Partnership Q raises $10,000,000 on October 25,
1996, by using this pool to issue related debt obligations with
multiple maturities. The transfer of the $10,000,000 to Partnership
Q is a substantial transfer (within the meaning of Sec. 301.7701(i)-
3(b)(2)).
(c) Duration of taxable mortgage pool classification--(1)
Commencement and duration. An entity is classified as a taxable
mortgage pool on the first testing day that it meets the definition of
a taxable mortgage pool. Once an entity is classified as a taxable
mortgage pool, that classification continues through the day the entity
retires its last related debt obligation.
(2) Testing day defined. A testing day is any day on or after
September 6, 1995, on which an entity issues a related debt obligation
(as defined in paragraph (b)(3) of this section) that is significant in
amount.
Sec. 301.7701(i)-4 Special rules for certain entities.
(a) States and municipalities--(1) In general. Regardless of
whether an entity satisfies any of the requirements of section
7701(i)(2)(A), an entity is not classified as a taxable mortgage pool
if--
(i) The entity is a State, territory, a possession of the United
States, the District of Columbia, or any political subdivision thereof
(within the meaning of Sec. 1.103-1(b) of this chapter), or is
empowered to issue obligations on behalf of one of the foregoing;
(ii) The entity issues the debt obligations in the performance of a
governmental purpose; and
(iii) The entity holds the remaining interests in all assets that
support those debt obligations until the debt obligations issued by the
entity are retired.
(2) Governmental purpose. The term governmental purpose means an
essential governmental function within the meaning of section 115. A
governmental purpose does not include the mere packaging of debt
obligations for re-sale on the secondary market even if any profits
from the sale are used in the performance of an essential governmental
function.
(3) Determinations by the Commissioner. If an entity is not
described in paragraph (a)(1) of this section, but has a similar
purpose, then the Commissioner may determine that the entity is not
classified as a taxable mortgage pool.
(b) REITs. [Reserved]
(c) Subchapter S corporations--(1) In general. An entity that is
classified as a taxable mortgage pool may not elect to be an S
corporation under section 1362(a) or maintain S corporation status.
(2) Portion of an S corporation treated as a separate corporation.
An S corporation is not treated as a member of an affiliated group
under section 1361(b)(2)(A) solely because a portion of the S
corporation is treated as a separate corporation under section 7701(i).
Margaret Milner Richardson,
Commissioner of Internal Revenue.
Approved: July 17, 1995.
Leslie Samuels,
Assistant Secretary of the Treasury.
[FR Doc. 95-19285 Filed 8-4-95; 8:45 am]
BILLING CODE 4830-01-U
