by One issue impacting the downturn in the real estate market is the inability of some lenders to revise the loan terms to avoid foreclosure. The packing of loans into a securitization structure was usually accomplished by using a REMIC or other tax-favorable structure. By adhering to the REMIC rules, the payments to the lender passed through the REMIC structure would not be taxed until received by the investors in the REMIC structure. REMICs are governed by Section 860A – 860G of the Internal Revenue Code.
One of the limitations in the REMIC structure is that the loans cannot be materially modified. If modified, the IRS imposes a hefty tax penalty. Section 860F(a)(1) imposes a tax on a REMIC 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.”860F(a)(2)
The IRS promulgated Rev. Proc. 2008-28 to give the servicers of residential mortgage loans some more flexibility in providing foreclosure relief, without jeopardizing the capital structure of the mortgage loan securitization. This revenue procedure applies to “a modification of a mortgage loan that is held by a REMIC, or by an investment trust, if all of the following conditions are satisfied:
- The real property securing the mortgage loan is a residence that contains fewer than five dwelling units.
- The real property securing the mortgage loan is owner-occupied.
- (1) If a REMIC holds the mortgage loan, then as of either the startup day or the end of the 3–month period beginning on the startup day, no more than ten percent of the stated principal of the total assets of the REMIC was represented by loans the payments on which were then overdue by 30 days or more; or (2) If an investment trust holds the mortgage loan, then as of all dates when assets were contributed to the trust, no more than ten percent of the stated principal of all the debt instruments then held by the trust was represented by instruments the payments on which were then overdue by 30 days or more.
- The holder or servicer reasonably believes that there is a significant risk of foreclosure of the original loan. This reasonable belief may be based on guidelines developed as part of a foreclosure prevention program similar to that described in Section 2 of this revenue procedure or may be based on any other credible systematic determination.
- The terms of the modified loan are less favorable to the holder than were the unmodified terms of the original mortgage loan.
- The holder or servicer reasonably believes that the modified loan presents a substantially reduced risk of foreclosure, as compared with the original loan.”
If the modification meets those requirements, then
- The IRS will not challenge a securitization vehicle’s qualification as a REMIC on the grounds that the modifications are not among the exceptions listed in § 1.860G–2(b)(3);
- The IRS will not contend that the modifications are prohibited transactions under section 860F(a)(2) on the grounds that the modifications resulted in one more dispositions of qualified mortgages and that the dispositions are not among the exceptions listed in section 860F(a)(2)(A)(i)–(iv);
- The IRS will not challenge a securitization vehicle’s classification as a trust under section 301.7701-4(c) on the grounds that the modifications manifest a power to vary the investment of the certificate holders; and
- The IRS will not challenge a securitization vehicle’s qualification as a REMIC on the grounds that the modifications resulted in a deemed reissuance of the REMIC regular interests.
This revenue procedure governs determinations made by the Service on or after May 16, 2008, with respect to loan modifications that are effected on or before December 31, 2010.
I just skimmed the procedure, so I very much appreciated your succinct summary of it. Do you think that the purpose of this is to protect investors as well as homeowners, or is it slanted in one way or another?
I think the purpose is to protect investors so they can help homeowners. Prior to this Rev. proc., the securitized lenders could help the borrowers without experiencing adverse consequence on top of the writing down the loan.