PORTFOLIO

REMICs, FASITs and Other Mortgage-Backed Securities (Portfolio 741)

Tax Management Portfolio, REMICs, Mortgage REITs, Mortgage Trusts and Other Real Estate Mortgage Securitization Vehicles, No. 741-2nd, focuses on the most-used vehicles for repackaging interests in home and commercial mortgages and reselling those interests into the secondary market. Real estate mortgage investment conduits (REMICs) is the primary topic and the portfolio considers in detail: (i) the tax requirements for qualifying and remaining qualified as a REMIC, (ii) the tax consequences of funding and operating a REMIC, and (iii) the treatment of the holders of the REMIC's regular interests (which are deemed to be debt whether they meet the usual tax conditions for debt classification or not) and the REMIC's residual interests (the income on which cannot be reduced by deductions).

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DESCRIPTION

Tax Management Portfolio, REMICs, Mortgage REITs, Mortgage Trusts and Other Real Estate Mortgage Securitization Vehicles, No. 741-2nd, focuses on the most-used vehicles for repackaging interests in home and commercial mortgages and reselling those interests into the secondary market. Real estate mortgage investment conduits (REMICs) is the primary topic and the portfolio considers in detail: (i) the tax requirements for qualifying and remaining qualified as a REMIC, (ii) the tax consequences of funding and operating a REMIC, and (iii) the treatment of the holders of the REMIC's regular interests (which are deemed to be debt whether they meet the usual tax conditions for debt classification or not) and the REMIC's residual interests (the income on which cannot be reduced by deductions).


Mortgage Trusts, which were the initial mortgage securitization vehicle and the predecessor to REMICs are also considered. Special attention is paid to classification issues, in particular, the ways in which trust property can be shared without causing the securitization vehicle to be classified as a partnership or corporation. The distinction between foreign and domestic trusts is touched on and so is the distinction between trusts that issue debt and trusts that issue certificates representing ownership of debt instruments held by the trust.


Mortgage Real Estate Investment Trusts (Mortgage REITs) are discussed as an alternative to REMICs. Mortgage REITs issue mortgage backed debt instruments through taxable mortgage pools. These vehicles are commonly referred to as “REIT-TMPs.” As part of the general discussion of Mortgage REITs, the portfolio explains the advantages of REIT-TMPs over REMICs (greater flexibility in managing mortgage assets) and their disadvantages (unlike REMIC regular interests, which are deemed to be debt, REIT-TMP instruments sold to investors must qualify as debt under the usual tax rules for distinguishing debt from equity).


Because of the prevalence of distressed mortgages, the REMIC, Mortgage Trust and Mortgage REIT discussions all consider the special rules published by the IRS and Treasury that enable mortgage securitization vehicles to address problem loans without jeopardizing the favorable tax treatment of such vehicles.


Financial asset securitization investment trusts (FASITs) are not discussed in detail. To provide help to the practitioner, however, the worksheets provide the statute and legislative history and the proposed regulations and explanation. Other worksheets discuss special aspects of foreclosing on REIT-held mortgages and modifying REMIC-held mortgages. REMIC liquidation plans, examples of two-tier REMIC structures and general REMIC tax provisions (reporting and filing duties) are also provided.


Buy REMICs, FASITs and Other Mortgage-Backed Securities (Portfolio 741) now


AUTHORS

MARSHALL D. FEIRING
Marshall D. Feiring, B.A., cum laude, New York University (1974); J.D., Brooklyn Law School (1978); L.L.M. (Tax), Boston University School of Law (1980); member, American Bar Association; Counsel — Sidley Austin L.L.P., New York, N.Y.; formerly, Senior Technician Reviewer (Tax) IRS Office of Associate Chief Counsel (Financial Institutions & Products); Assistant to the Branch Chief, IRS Office of Associate Chief Counsel (Passthroughs and Special Industries).

TABLE OF CONTENTS

Detailed Analysis

I. Introduction

Introductory Material

A. Development of Pass–Through Mortgage–Backed Securities

1. General

2. Historical Highlights

B. Growth of Pass–Through Mortgage–Backed Securities

C. Mortgage–Backed Securities as an Investment

1. Vehicle for Investing in Mortgages

2. Lender's Alternatives

II. Explanation of Mortgage–Backed Securities

A. Types of Mortgages

1. General

2. Adjustable–Rate Mortgages

3. Multifamily Mortgages

4. Commercial Mortgages

a. General

b. Credit Rating

B. Types of Mortgage–Backed Securities

1. Pass–Through Securities

a. Definition

b. Investor Considerations

2. Mortgage–Backed Bonds

a. Straight Mortgage–Backed Bond

(1) General

(2) Legal Limitations on Financial Institution Issuers

b. Zero–Coupon Mortgage–Backed Bonds

c. Pay–Through Mortgage–Backed Bonds

(1) General

(2) Advantages Over Straight Mortgage–Backed Bonds

d. Pay–Through Mortgage–Backed Builder Bonds

(1) General

(2) Use of a Subsidiary

(3) Attributes

(4) Installment Sale Treatment

(5) Taxation of Bondholders

e. Pay–Through Bonds/Collateralized Mortgage Obligations (CMOs)

(1) General

(2) Evaluating CMOs

(3) CMO Attributes

(4) Private–Issue Obligations/CMO Developments

(5) Companion CMOs

(6) Accounting Treatment

(7) Tax Treatment

(a) Issuer: Classification as Debt or Asset Sale

(b) Holder: Classification as Debt Versus Equity

(c) Taxation of Holders

(d) Discount Income

(e) Withholding Taxes

(f) Investors

f. Collateralized Mortgage Loan

3. Direct Pay Letter of Credit

4. Collateralized Preferred Stock

a. General

b. Tax Aspects

(1) Dividends–Received Deduction

(2) Issuance Through a Subsidiary

5. Earnings–Based Account (Participation Certificate of Deposit)

6. Senior/Subordinated Securities

7. Stripped Securities

a. General

b. Tax Implications

c. Use in a REMIC

III. Real Estate Mortgage Investment Conduit (REMIC)

Introductory Material

A. Qualifications as a REMIC

B. Composition of a REMIC

1. Regular Interests

2. Residual Interest

C. Treatment of Transfers to a REMIC

D. Taxation

1. Regular Interest Holders

2. Residual Interest Holders

3. Taxation of REMICs

4. Treatment of REMIC Interests Held by Financial Institutions and REITs

5. Tax Filing and Information Return Requirements

6. Liquidation of a REMIC

E. Use of Other Vehicles to Hold Mortgage Pools

F. Advantages of REMICs

G. Use with Subordinated Interests

H. Use with Shifting Interest

I. Taxable Mortgage Pool

J. Future of REMICs

IV. Financial Asset Securitization Investment Trust

A. Background

B. Qualification as a FASIT

1. Election to Be Treated as a FASIT

2. Regular Interests and the Ownership Interest

a. Regular Interests

(1) In General

(2) High-Yield Regular Interests

(3) Regular Interests Held by Foreign Residents

b. The Ownership Interest

3. Permitted Assets

a. Cash and Cash Equivalents

b. Permitted Debt Instruments

(1) In General

(2) Short-Term Debt Instruments Issued by the Owner or a Related Person

(3) Debt Instruments That Are Not Permitted Assets

c. Foreclosure Property

d. Hedges and Guarantees

(1) In General

(2) Hedges and Guarantees Issued by the Owner or a Related Person

(a) Hedges

(b) Guarantees

e. Contracts to Acquire Hedges or Debt Instruments

4. Prohibited Transactions

a. In General

b. Acquisitions Presumed Not to Be Loan Origination

5. Cessation of a FASIT

a. Consequences of Cessation for the FASIT and the Underlying Arrangement

b. Consequences of Cessation for the Owner

c. Consequences of Cessation for Regular Interest Holders

C. Tax Treatment of the Owner

1. In General

2. Gain Recognition on Property Transferred to a FASIT or Supporting FASIT Regular Interests

3. Determining the Value of Property

a. In General

b. Special Valuation Rule

(1) Reasonably Expected Payments

(2) Special Rules

(a) Beneficial Ownership Interests

(b) Stripped Interests

(c) Contemporaneous Purchase and Transfer of Debt Instruments

(d) Guarantees

4. Transfers of Ownership Interests

5. Reporting and Other Procedural Requirements

Owner's Annual Reporting Requirements

b. Treatment under Subtitle F

D. Tax Treatment of a FASIT Regular Interest

E. Transitional Rule for Pre-Effective Date FASITs

1. In General

2. Safe-Harbor Method for Determining FASIT Gain

a. Step One: Establishing Pools of Assets

b. Step Two: Determining FASIT Gain or Loss at the Pool Level

c. Step Three: Determining the Percentage of Total FASIT Gain That Must Be Recognized by the End of the Current Taxable Year

d. Step Four: Determining the Total Amount of FASIT Gain Not Attributed to Pre-Effective Date FASIT Interests

e. Step Five: Determining the Amount of FASIT Gain or Loss to Be Recognized in the Taxable Year

3. Example

a. Facts

b. Status as a Pre-Effective Date FASIT

c. Facts: 1999

d. FASIT Gain Recognition for 1999

e. Facts: 2000

f. FASIT Gain Recognition for 2000

F. Anti-Abuse Rule

V. Pass–Through Mortgage–Backed Securities

A. Certificate Yield

1. Prepayments

2. Evaluating Value

a. Twelve–Year Prepayment

b. FHA Experience

c. Constant Percent Prepayment Rates

d. Public Securities Association Method

3. Investor Strategy

a. Market Evaluation

b. Consistency of Prepayments

c. Timing of Pass–Through

B. Operation of Pass–Through Security Program

1. Lender Application to Participate

2. Formation of Mortgage Pools

3. Documents

4. Evidence of Ownership

5. Trading Securities

C. Credit Ratings

VI. Government–Sponsored Entities in Secondary Mortgage Market

A. Government National Mortgage Association

1. History

2. Pass–Through MBS Guarantee

3. Programs

a. History

b. Operations

c. Procedures

d. Mortgages in Pools

4. Certificates

a. Denominations

b. Mutual Funds

c. Unit Trusts

d. Futures

B. Federal Home Loan Mortgage Corporation

1. History

2. Government Relationship

3. Statutory Limitations on Mortgage Purchases by Freddie Mac and Fannie Mae

4. Taxation

5. Pass–Through MBS Guarantee

C. Federal National Mortgage Association

1. History

2. Government Relationship

3. Statutory Limitations on Mortgage Purchases

4. Taxation

5. Pass–Through MBS Denominations

6. Pass–Through MBS Guarantee

D. Comparison of Fannie Mae/Freddie Mac Pass–Through MBS Programs

E. Federal Agricultural Mortgage Corporation

VII. Investors in Pass–Through Mortgage–Backed Securities

A. Profile

B. Foreign

C. State–Regulated Entities

VIII. Securities and Regulatory Laws

A. ERISA

1. General

2. Diversification Requirement

3. Party–in–Interest Rules

B. Securities and Regulatory Laws

1. Securities Act of 1933 Registration Requirements

a. General

b. Exemptions

c. Methods of Registration

2. Securities Exchange Act of 1934

3. Regulation T

4. Restrictions on Thrift Institutions and National Banks/Mortgage–Backed Bonds

5. Restriction on Thrift Institutions and National Banks/Pass–Through MBSs

6. State–Chartered Mutual Savings Banks/ Mortgaged–Backed Bonds

7. The Glass–Steagall Act

8. State Blue Sky Laws

9. Investment Advisers Act of 1940

10. Trust Indenture Act of 1939

11. Investment Company Act of 1940

12. NYSE Margin Requirements

13. Dealer Regulation

14. Bank Holding Company Act

C. Legality of Pass–Through Mortgage–Backed Security Investments

IX. Structure of Mortgage Pools for Pass-Through Mortgage-Backed Securities

A. Issuer's Objectives

B. Forms of Structuring Mortgage Pools

1. Real Estate Investment Trust

2. Investment Company

3. Limited Partnership

4. Grantor Trust

5. Real Estate Mortgage Investment Conduit (REMIC)

6. Limited Liability Companies

C. Characterization of Mortgage Pools for Tax Purposes

1. Characterization of a Mortgage Pool as a Business Entity Taxable as a Corporation

2. Classification of Mortgage Pool as a Business Entity Taxable as a Partnership

3. Classification of Mortgage Pool as a Grantor Trust

D. Real Estate Mortgage Investment Conduits (REMICs)

E. Characterization of Sale of Mortgage Loans for Accounting Purposes

X. Taxation of Pass–Through Mortgage–Backed Security Certificate Holders

A. Receipt of Certificates

B. Items of Income and Deduction

1. General

2. Backup Withholding

3. Withholding for Foreign Certificate Holders

4. Market Discount Income

5. Original Issue Discount (OID) and Premium

6. Stripped Bonds

7. Interest Income

8. Ginnie Maes

C. Status of Pass–Through MBSs Held by REITs, Domestic Building and Loan Associations and Other Thrift Institutions

XI. Taxation of Pass–Through Mortgage–Backed Security Issuer

A. Receipt of Mortgages by Issuer and Issuance of Certificates

B. Treatment by Issuer of Income and Expenses Attributable to the Pool of Mortgages

C. Grantor Trust Rules

D. Reporting Obligations

1. General Requirements

a. Pre-2007 Information Reporting

b. Post-2006 Information Reporting.

(1) In General

(2) Providing Information

(3) De Minimis Tests

(4) Safe Harbor Reporting

(5) Middlemen's Responsibilities

(6) Form 1099

2. Abandonment and Foreclosures

3. Taxpayer Identification Number Reporting (Backup Withholding)

XII. Reporting Obligations on Seller/Servicers of Pass–Through Mortgage–Backed Securities

XIII. The Future of the Secondary Mortgage Market


WORKING PAPERS

Working Papers

Table of Worksheets

Worksheet 1 Comparison of Pass–Through Mortgage–Backed Securities.

Worksheet 2 Legislative History of REMICs (H.R. 3838, Sections 671–675 and Excerpts from Conference Report to Accompany H.R. 3838).

Worksheet 3 Sample Prospectus for a Real Estate Mortgage Investment Conduit (REMIC).

Worksheet 4 Form 1066 and Form 8811

Worksheet 5 Preambles to Temporary and Final REMIC Regulations [860A through 860G]

Worksheet 6 Preamble to Proposed REMIC Regulations on Notice of Allocation of Allocable Investment Expense

Worksheet 7 Chart of REMIC Tax and Information Return Requirements.

Worksheet 8 Legislative History of FASITs

Worksheet 9 Preamble to Proposed Fasit Regulations

Worksheet 10 IRS Final Rules (T.D. 9004) on Safe Harbor Transfers of Noneconomic Residual Interests in Real Estate Mortgage Investment Conduits

Worksheet 11 Preamble to Proposed Regulations on Inducement Fees Paid to Holders of Noneconomic Residual Interests in REMICs

Bibliography

OFFICIAL

Statutes:

Regulations:

Legislative History:

Treasury Rulings:

Cases:

UNOFFICIAL

Periodicals:

1983

1984

1985

1986

1988

1989

1991

1993

1996

1997