Background: GLAM 2013-001 holds that “where the loan-originating Bank acquires real property through foreclosure or deed-in-lieu of foreclosure and promptly attempts to sell the OREO without improvement, …the property is not 'property acquired for resale' within the meaning of [IRC] § 263A". The GLAM reaches this conclusion even though it is assumed, as a factual matter, that the bank holds the OREO property for sale as described in IRC § 1221(a)(1). In reaching its conclusion, the GLAM considered Treas. Reg. § 1.263A-1(b)(13) which provides that the origination of loans is not considered the acquisition of property for resale, notwithstanding the frequency with which the bank sells the loans it originates or the percentage of its originated loans that it sells. The GLAM concludes that a bank’s acquisition of OREO property through either a foreclosure proceeding or a deed-in-lieu of foreclosure transaction and the bank’s subsequent sale of the OREO property does not convert the bank into a reseller for purposes of IRC § 263A(b)(2)(A). The GLAM views the foreclosure proceeding or deed-in-lieu of foreclosure transaction and the subsequent sale of the OREO property as an extension of the bank’s loan origination activity. The bank in these situations is acting in its capacity as a lender and not as a reseller of property, as the bank only takes title and possession of the property as a last resort to recover funds. As a result, under the circumstances described in the GLAM, the property is not property acquired for resale within the meaning of IRC § 263A(b)(2)(A).
QUESTION #1 – The GLAM addresses OREO property held by a bank that originated the underlying loan. If the bank did not originate the underlying loan, but acquired it from another bank, is OREO property taken through foreclosure proceedings or by deed-in-lieu of foreclosure “property acquired for resale” within the meaning of IRC § 263A(b)(2)(A)?
Answer – No. Although the GLAM specifically applies to OREO property held by a bank originating the underlying loan, it is LB&I’s view that the analysis in the GLAM should extend to a bank that acquires pre-existing loans, maintains a portfolio of mortgage loans, and, if mortgagors default on their loans, acquires foreclosed real estate in full or partial satisfaction of those loans.
QUESTION #2 – What is the appropriate tax treatment of the costs incurred by a bank in improving or remodeling property that is acquired through foreclosure proceedings or by deed-in-lieu of foreclosure?
Answer – The GLAM does not address whether the costs incurred by a bank to make improvements to OREO properties are subject to capitalization under IRC §§ 263(a) or 263A. Whether a particular amount is deductible as a repair or capitalizable as an improvement must be determined under Treas. Reg. § 1.263(a)-3T. Whether a bank engages in activity that rises to the level of “production” within the meaning of IRC § 263A(g)(1) depends on the facts and circumstances. However, general practice in the banking industry is to attempt to sell foreclosed properties quickly, without making more than basic repairs to the property. If an LB&I examiner proposes to treat a bank as producing OREO property for purposes of § 263A(b)(1), the examiner should discuss the issue with his or her manager.
QUESTION #3 – Does the GLAM address the issue of ordinary versus capital treatment of gains or losses on the disposition of the property that is “held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business” under IRC §1221(a)(1)?
Answer – No. The GLAM does not address the issue of whether the OREO property satisfies the requirements of IRC §1221(a)(1). The GLAM assumed that the bank held OREO property primarily for sale to customers in the ordinary course of business within the meaning of IRC § 1221(a)(1). As indicated in footnote 1 of the GLAM, whether property is held by a taxpayer primarily for sale to customers in the ordinary course of business within the meaning of IRC § 1221(a)(1) depends on the type and scope of the taxpayer’s activities involving OREO property. See Rev. Rul. 74-159, 1974-1 C.B. 232.
QUESTION #4 – What should Revenue Agents do if they previously issued Forms 5701 proposing to capitalize costs for OREO property?
Answer – To best carry out the position set forth in the GLAM, any previously issued Forms 5701 that propose to capitalize OREO expenses should be reconsidered, and, if necessary, revised or withdrawn to be consistent with the GLAM and Q&As 1-3.
QUESTION #5 – Does the National Office intend to issue a revenue procedure permitting an automatic change in method of accounting for a taxpayer that previously capitalized the costs of OREO property under IRC § 263A(b)(2)(A) and now wants to change to a permissible non-UNICAP method of accounting?
Answer – The National Office is considering issuing a revenue procedure permitting taxpayers to make an automatic change in method of accounting for OREO expenses. In the meantime, a bank that is not under examination will have to file a Form 3115, Application for Change in Accounting Method, under the advance consent procedures of Rev. Proc. 97-27, 1997-1 C.B. 680, in order to change its method of accounting for OREO expenses. However, a bank under examination by the Service may request that the LB&I examiners make the change in method of accounting for the years under examination pursuant to section 5 of Rev. Proc. 2002-18, 2002-1 C.B. 678. Alternatively, the bank may request advance consent to change its method to one that is consistent with the GLAM by obtaining district director consent pursuant to section 6.01(4) of Rev. Proc. 97-27.