Taxable mortgage pool rules now in effect.

• Author: Alexander, John W.

Newly formed mortgage-pool entities, and older pools that accept substantial new investment after 1991, need to be wary of the Sec. 7701(i) taxable mortgage pool (TMP) rules. Characterization of an entity as a TMP results in the pool being taxed as a corporation that cannot join in a consolidated return. Because the scope of these rules goes beyond entities that would otherwise be characterized as real estate mortgage investment conduits (REMICs) it is important to review them in any pooling of debt instruments.

Mortgage-backed securities (MBSs) are generally pools of mortgages that pass through the payments of principal and interest to investors, often in exotic arrangements that give different priorities to payment, and rates of return, to different classes. The so-called "Sears Regs" of Regs. Sec. 301.7701-4(c), finalized in 1986, would reclassify many multiple-class MBSs - nominally in trust form - as corporations unless (1) there is no power under the trust agreement to vary the investment of the MBS holders, (2) the trust is formed to facilitate direct investment in its assets and (3) the existence of multiple classes of ownership interests is incidental to that purpose.

The REMIC rules (Secs. 860A through 860G) were enacted in 1986 to provide a safe harbor for multiple-class MBSs from characterization as corporations, with the intention that REMICs would be the exclusive passthrough entity for issuing multiple-class MBSs. Electing REMIC status allows an entity to offer investments backed by real estate mortgages with different payout schedules, rates of return and cash flows, without being subject to entity-level tax.

Congress decided in 1986 that any entity formed after 1991 that offered real-estate mortgage debt-backed securities with two or more maturities and that did not elect REMIC status was to be taxed as a corporation and would not be eligible to join in filing a consolidated return. Under Sec. 7701(i), a TMP is an entity - "substantially all" of whose assets are debt obligations (or interests therein), more than 50% of which are real estate mortgages (or interests therein); - that is the obligor under debt obligations with two or more maturity dates (or with the same maturity but different rights relating to acceleration of maturity); and - whose payments on the...