Real estate: IRS expands list of permitted loan modifications to include commercial mortgages held by REMICs.

• Author: Coony, Tom
• Position: Real estate mortgage investment conduits

The IRS has issued final regulations (T.D. 9463) expanding the list of permitted loan modifications to include certain modifications of commercial mortgages held by real estate mortgage investment conduits (REMICs). The final regulations are effective September 16, 2009, and adopt the 2007 proposed regulations (REG-127770-07) with modifications. The IRS is requesting comments on further amendments needed to the regulations in Notice 2009-79. The Service also released Rev. Proc. 2009-45, announcing that it would not challenge the tax status of REMICs or investment trusts that modified mortgage loans under certain conditions.

REMIC Provisions

The REMIC provisions under Secs. 860A-860G create a passthrough vehicle that issues multiple classes of interests in pools of residential or commercial mortgage loans. All income from the mortgage loans in the REMIC is taxed to the holders of regular and residual interests in the REMIC. Among the requirements for qualification is that mortgage loans held by the REMIC must consist of qualified mortgages that are principally secured by an interest in real property. All loans must be acquired on the REMIC's startup day or within three months thereafter, except that a REMIC may exchange a defective loan for a qualified replacement mortgage for up to two years.

If an obligation is significantly modified, the modified obligation is treated as one that was newly issued in exchange for the unmodified obligation that it replaced (Regs. Sec. 1.860G-2(b)( 1)). If a significant modification occurs after the obligation has been contributed to the REMIC and the modified obligation is not a qualified replacement mortgage, the modified obligation will not be a qualified mortgage, and the deemed disposition of the unmodified obligation will be a prohibited transaction under Sec. 860F(2). A prohibited transaction is subject to a 100% tax on the net income from the transaction under Sec. 860(a)(1).

A significant modification is any change in the obligation's terms that would be treated as an exchange of obligations under the rules for determining gain or loss in Sec. 1001 and the regulations (Regs. Sec. 1.860G-2(b)(2)). Regs. Sec. 1.1001-3 defines what modification is and provides that a modification that is significant will be treated as a deemed exchange of the original loan for a new loan. Regs. Sec. 1.860G-2(b)(3) sets forth four types of loan modifications expressly permitted without regard to Regs. Sec. 1.1001-3:

* Changes in the obligation's terms occasioned by default or a reasonably foreseeable default;

* Assumption of the obligation;

* Waiver of a due-on-sale clause or a due-on-encumbrance clause; and

* Conversion of an interest rate by a mortgagor under the terms of a convertible mortgage.

In Notice 2007-17...