IRS Issues Guidance on the Impact of Mortgage Loan Forbearances on REMICs and Investment Trusts
In response to requests to provide guidance on the impact of mortgage loan forbearance programs on the tax treatment of securitization vehicles, such as real estate mortgage investment conduits (“REMICs”) and investment trusts, the IRS issued Revenue Procedure 2020-26. The IRS establishes that forbearance programs offered as COVID-19 relief will not jeopardize the tax treatment and qualifications of REMICs and investment trusts.
The Rev. Proc. applies to forbearances granted under the CARES Act, and other forbearance programs offered by loan servicers and holders, either voluntarily or state-mandated, for borrowers experiencing financial hardship due to the COVID-19 emergency.
Forbearances of mortgage loans held by investment trusts do not manifest a power to vary the investment of the certificate holders if the forbearances are granted to borrowers (1) under the CARES Act or (2) under a forbearance program for borrowers affected by COVID-19 offered by a loan service or holder between March 27, 2020, and December 31, 2020.
Under section 301.7701—4(a) of the Procedure and Administration Regulations, an arrangement is treated as a trust if the purpose is to vest in trustees, not the beneficiaries, the responsibility for the protection and conservation of the property. 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 trust.
The IRS has found that forbearances do not jeopardize an investment trust’s classification as a trust for federal tax purposes.
Forbearances and related modifications of mortgage loans held by REMICs are not treated as resulting in a newly issued loan for purposes of § 1.860G-2(b)(1) of the Income Tax Regulations.
Under section 1.860G-2(b)(1), a significant modification to an obligation held by a REMIC will cause the obligation to be treated as “newly issued,” which causes the obligation to lose its status as a “qualified mortgage” transferred on the startup date. In order for an entity to qualify as a REMIC, substantially all of the assets of the entity must consist of “qualified mortgages” and “permitted investments.”
There are certain exceptions to loan modifications that would ordinarily be considered “significant” under the applicable rules. For example, if the change in terms of the obligation is occasioned by default or a reasonably foreseeable default, the change is not “significant.”
So does a loan forbearance qualify as a “signification modification” to the loan that would jeopardize the entity’s qualification as a REMIC? According to the IRS, it does not.
Forbearances and related modifications of mortgage loans held by REMICs are not prohibited transactions under Section 860F(a)(2) of the Internal Revenue Code.
Under Code section 860F(a)(1), the net income derived from prohibited transactions is taxed at a rate equal to 100%. Because forbearances are not prohibited transactions, they do not subject the REMICs to the 100-percent tax.
Also, under Code section 860C(b)(1), the taxable income of a REMIC is determined under an accrual method of accounting, except that any items of income, gain, loss, or deduction allocable to a “prohibited transaction” should not be taken into account. Thus, any income, gain, loss or deduction allocable to the forbearance of the mortgage loan may be taken into account under the accrual method of accounting.
Forbearances and related modifications of mortgage loans held by REMICs do not result in a deemed “reissuance” of the REMIC regular interests.
For an entity to qualify as a REMIC, all of the interests in the entity must consist of one or more classes of regular interests and a single class of residual interest, all of which must be issued on the startup day.
The IRS has determined that, for any mortgage loans held by a REMIC, a forbearance of the loan does not result in a deemed reissuance of the REMIC regular interests that would jeopardize the entity’s status as a REMIC.
Delays and shortfalls in payments associated with or caused by forbearances of mortgage loans held by REMICs are contingencies under § 1.860G-1(b)(3)(ii) of the Income Tax Regulations that can be disregarded.
Generally, the principal amount of a regular interest may not be contingent. However, section 1.860G-1(b)(3) lists contingencies that do not prevent an interest in a REMIC from being a regular interest.
Under section 1.860G-1(b)(3)(ii), which, in part, provides that “an interest does not fail to qualify as a regular interest solely because the amount or the timing of payments of principal or interest … is affected by defaults on qualified mortgages and permitted investments,” delays in payment caused by forbearances do not prevent an interest in a REMIC from being a regular interest.
If a REMIC acquires a mortgage loan with respect to which the borrower previously received a forbearance (“Forbearance Loan”), that prior forbearance is not treated as evidence that the entity had improper knowledge of an anticipated default under § 1.856-6(b)(3) of the Income Tax Regulations.
Under section 1.856—6(b)(3), if a REMIC acquired a loan when the REMIC knew or had reason to know that default would occur, also known as “improper knowledge,” then the property cannot be treated as foreclosure property, which is a permitted investment for a REMIC. As noted above, substantially all of the assets of a REMIC must consist of qualifying mortgages and permitted investments.
Accordingly, if a REMIC acquires a Forbearance Loan, and the REMIC subsequently acquires the collateral upon foreclosure, then the forbearance relief does not prevent the collateral from being a permitted investment of the REMIC.
If a REMIC acquires a Forbearance Loan, the prior forbearance is not taken into account in the determination of the origination date of the mortgage loan for purposes of § 1.860G-2(a)(1) of the Income Tax Regulations.
For a loan to be a qualified mortgage, the collateral must meet one of the loan-to-value ratio tests under section 1.860G-2(a)(1)(i) and (ii). These ratios are tested as of the origination date of the loan, except that if the loan has been significantly modified then the loan is deemed to be originated on the date of modification.
In Rev. Proc. 2020—26, the IRS established that forbearance relief does not constitute a significant modification that would affect the origination date of the mortgage loan.