Internal Revenue Bulletin: 2008-31
August 4, 2008
Table of Contents
This revenue procedure describes the conditions under which modifications to certain subprime mortgage loans will not cause the Internal Revenue Service (Service) to challenge the tax status of certain securitization vehicles that hold the loans or to assert that those modifications create a liability for tax on a prohibited transaction.
The purpose of this revenue procedure is to provide certainty in the current economic environment with respect to certain potential tax issues that may be implicated by fast track loan modifications, as described below. No inference should be drawn about whether similar consequences would obtain if a transaction falls outside the limited scope of this revenue procedure. Furthermore, there should be no inference that, in the absence of this revenue procedure, transactions within its scope would have impaired the tax status of securitization vehicles or would have created liability for tax on a prohibited transaction.
Rev. Proc. 2007-72, 2007-52 I.R.B. 1257, provided similar guidance regarding fast-track loan modifications that were effected in a manner consistent with certain principles, recommendations, and guidelines (the “Original Framework”), which the American Securitization Forum (“ASF”) released on December 6, 2007. In July 2008, the ASF released an updated Framework, which covers additional fast-track loan modifications.
This revenue procedure amplifies and supersedes Rev. Proc. 2007-72 by extending its provisions to these additional loan modifications.
.01 On July 8, 2008, the American Securitization Forum (“ASF”) released a document entitled, “Statement of Principles, Recommendations and Guidelines for a Streamlined Foreclosure and Loss Avoidance Framework for Securitized Subprime Adjustable Rate Mortgage Loans” (the “July 2008 Framework”). An Executive Summary of the July 2008 Framework (entitled “Streamlined Foreclosure and Loss Avoidance Framework for Securitized Subprime Adjustable Rate Mortgage Loans”) was released simultaneously and is attached as an Appendix to this revenue procedure.
.02 Both the Original Framework and the July 2008 Framework have been broadly supported as appropriate steps in addressing certain risks in the current economic environment.
.03 The July 2008 Framework applies to first-lien subprime residential adjustable rate mortgage (ARM) loans that—
(1) Have an initial fixed rate period of 36 months or less (including “2/28s” and “3/27s”);
(2) Were originated between January 1, 2005, and July 31, 2007;
(3) Are included in securitized pools; and
(4) Have an initial interest rate reset date between January 1, 2008, and July 31, 2010.
This revenue procedure refers to these instruments as “Loans.”
.04 The July 2008 Framework provides a “fast track” procedure for modifying Loans in advance of an initial, or any subsequent, interest rate reset date and details the criteria for determining which Loans are eligible for the procedure. Modifications pursuant to the procedure are referred to as “fast track modifications.”
.05 A fast track modification affects the interest rate on the Loan, generally for five years following the date on which the rate would have reset in the absence of the modification. During the period affected by the modification, the interest rate on the modified Loan is generally fixed at the rate in effect prior to the upcoming reset date.
.01 Real Estate Mortgage Investment Conduits (REMICs) are widely used securitization vehicles for mortgages. REMICs are governed by sections 860A through 860G of the Internal Revenue Code.
.02 For an organization to qualify as a REMIC, all of the interests in the organization must consist of one or more classes of regular interests and a single class of residual interests, see section 860D(a), and those interests must be issued on the startup day, within the meaning of § 1.860G-2(k) of the Income Tax Regulations.
.03 A regular interest is one that is designated as a regular interest and whose terms are fixed on the startup day. Section 860G(a)(1). In addition, a regular interest must (1) unconditionally entitle the holder to receive a specified principal amount (or other similar amount), and (2) provide that interest payments, if any, at or before maturity are based on a fixed rate (or to the extent provided in regulations, at a variable rate).
.04 An interest issued after the startup day does not qualify as a REMIC regular interest.
.05 Under section 860D(a)(4), an entity qualifies as a REMIC only if, among other things, as of the close of the third month beginning after the startup day and at all times thereafter, substantially all of its assets consist of qualified mortgages and permitted investments. This asset test is satisfied if the entity owns no more than a de minimis amount of other assets. See § 1.860D-1(b)(3)(i). As a safe harbor, the amount of assets other than qualified mortgages and permitted investments is de minimis if the aggregate of the adjusted bases of those assets is less than one percent of the aggregate of the adjusted bases of all of the entity’s assets. § 1.860D-1(b)(3)(ii).
.06 With limited exceptions, a mortgage loan is not a qualified mortgage unless it is transferred to the REMIC on the startup day in exchange for regular or residual interests in the REMIC. See section 860G(a)(3)(A)(i).
.07 The legislative history of the REMIC provisions indicates that Congress intended the provisions to apply only to an entity that holds a substantially fixed pool of real estate mortgages and related assets and that “has no powers to vary the composition of its mortgage assets.” S. Rep. No. 99-313, 99th Cong., 2d Sess. 791-92; 1986-3 (Vol. 3) C.B. 791-92.
.08 Section 1.1001-3(c)(1)(i) defines a “modification” of a debt instrument as any alteration, including any deletion or addition, in whole or in part, of a legal right or obligation of the issuer or holder of a debt instrument, whether the alteration is evidenced by an express agreement (oral or written), conduct of the parties, or otherwise. Section 1.1001-3(e) governs which modifications of debt instruments are “significant.” Under § 1.1001-3(b), for most federal income tax purposes, a significant modification produces a deemed exchange of the original debt instrument for a new debt instrument.
.09 Under § 1.860G-2(b), related rules apply to determine REMIC qualification. Except as specifically provided in § 1.860G-2(b)(3), if there is a significant modification of an obligation that is held by a REMIC, then the modified obligation is treated as one that was newly issued in exchange for the unmodified obligation that it replaced. See § 1.860G-2(b)(1). For this purpose, the rules in § 1.1001-3(e) determine whether a modification is “significant.” See § 1.860G-2(b)(2). Thus, even if an entity initially qualifies as a REMIC, one or more significant modifications of loans held by the entity may terminate the qualification if the modifications cause less than substantially all of the entity’s assets to be qualified mortgages.
.10 Certain loan modifications, however, are not significant for purposes of § 1.860G-2(b)(1), even if the modifications are significant under the rules in § 1.1001-3. In particular, under § 1.860G-2(b)(3)(i), if a change in the terms of an obligation is “occasioned by default or a reasonably foreseeable default,” the change is not a significant modification for purposes of § 1.860G-2(b)(1), regardless of the modification’s status under § 1.1001-3.
.11 Section 860F(a)(1) imposes a tax on REMICs equal to 100 percent of the net income derived from “prohibited transactions.” The disposition of a qualified mortgage is a prohibited transaction unless the “disposition [is] pursuant to-(i) the substitution of a qualified replacement mortgage for a qualified mortgage . . . , (ii) a disposition incident to the foreclosure, default, or imminent default of the mortgage, (iii) the bankruptcy or insolvency of the REMIC, or (iv) a qualified liquidation.” Section 860F(a)(2)(A).
.01 Section 301.7701-2(a) of the Procedure and Administration Regulations defines a “business entity” as any entity recognized for federal tax purposes (including an entity with a single owner that may be disregarded as an entity separate from its owner under § 301.7701-3) that is not properly classified as a trust under § 301.7701-4 or otherwise subject to special treatment under the Code.
.02 Section 301.7701-4(a) provides that an arrangement is treated as a trust if the purpose of the arrangement is to vest in trustees responsibility for the protection and conservation of property for beneficiaries who cannot share in the discharge of this responsibility and, therefore, are not associates in a joint enterprise for the conduct of business for profit.
.03 Section 301.7701-4(c) provides that an “investment” trust is not classified as a trust if there is a power under the trust agreement to vary the investment of the certificate holders.
.01 This revenue procedure applies to the following transactions occurring on or before July 31, 2010—
(1) A fast track modification of a Loan pursuant to the July 2008 Framework; and
(2) A second-lien holder’s action of subordinating its lien to any new lien that may arise under a Loan as the result of such a fast track modification.
.02 If the July 2008 Framework is materially modified after July 8, 2008, this revenue procedure does not necessarily apply to fast track modifications under the modified Framework or to second-lien subordinations to accommodate those modifications.
In the case of one or more transactions to which this revenue procedure applies—
.01 The Service will not challenge a securitization vehicle’s qualification as a REMIC on the grounds that the transactions are not among the exceptions listed in § 1.860G-2(b)(3);
.02 The Service will not contend that the transactions are prohibited transactions under section 860F(a)(2) on the grounds that the transactions resulted in one or more dispositions of qualified mortgages and that the dispositions are not among the exceptions listed in section 860F(a)(2)(A)(i)-(iv);
.03 The Service will not challenge a securitization vehicle’s classification as a trust under § 301.7701-4(c) on the grounds that the transactions manifest a power to vary the investment of the certificate holders; and
.04 The Service will not challenge a securitization vehicle’s qualification as a REMIC on the grounds that the transactions resulted in a deemed reissuance of the REMIC regular interests.
For the treatment of mortgage loans modified pursuant to certain foreclosure prevention programs, see Rev. Proc. 2008-28, 2008-23 I.R.B. 1054.
Rev. Proc. 2007-72 is amplified and, as amplified, is superseded.
The principal author of this revenue procedure is Diana Imholtz of the Office of Associate Chief Counsel (Financial Institutions and Products). For further information, contact Ms. Imholtz at (202) 622-3930 (not a toll-free call).
||Appendix to Revenue Procedure 2008-47|
|American Securitization ForumStreamlined Foreclosure and Loss Avoidance Framework forSecuritized Subprime Adjustable Rate Mortgage Loans|
|July 8, 2008|
|This streamlined framework applies to all first lien subprime residential adjustable rate mortgage (ARM) loans that have an initial fixed rate period of 36 months or less (including “2/28s” and “3/27s”), referred to below as “subprime ARM loans” that:|
|This streamlined framework may be applied to subprime ARM loans in advance of an initial, or any subsequent, reset date. Typically, servicer/borrower communication should begin 120 days prior to the initial reset date.|
|As a general overview, under this streamlined framework, if the loan is current and is eligible for refinance, then it should be refinanced. If the loan is current but is not eligible for a refinance, then it would be eligible for a streamlined modification if: the property is occupied as the borrower’s primary residence; the borrower meets the “FICO test”; and the payment amount would go up by more than 10% over the current payment amount at the upcoming reset.|
|Under this framework, subprime ARM loans are divided into 3 segments.|
|Segment 1 includes current (as defined below) loans where the borrower is likely to be able to refinance into any available mortgage product, including FHA, FHA Secure or readily available mortgage industry products.|
|Segment 2 includes current loans where the borrower is unlikely to be able to refinance into any readily available mortgage industry product.|
|Segment 3 includes loans where the borrower is not current as defined above, demonstrating difficulty meeting the introductory rate.|
|Segment 1 — Refinance:|
|Segment 2 — Loan Modification:|
|Segment 3 — Loss Mitigation:|
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