[Federal Register Volume 60, Number 159 (Thursday, August 17, 1995)]
[Rules and Regulations]
[Pages 42785-42787]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 95-20319]
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DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[TD 8614]
RIN 1545-AS54
Real Estate Mortgage Investment Conduits
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Final and temporary regulations.
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SUMMARY: This document contains final regulations relating to variable
rate interest payments and specified portion interest payments on
regular interests in real estate mortgage investment conduits (or
REMICs). This action is necessary because of changes to the applicable
tax law made by the Tax Reform Act of 1986 and by the Technical and
Miscellaneous Revenue Act of 1988. These regulations provide guidance
to REMIC sponsors and investors.
DATES: These regulations are effective August 17, 1995.
For dates of applicability of these regulations, see Sec. 1.860A-1.
FOR FURTHER INFORMATION CONTACT: William P. Cejudo, (202) 622-3920 (not
a toll free number).
SUPPLEMENTARY INFORMATION:
Background
On April 20, 1994, temporary regulations (TD 8534) relating to
variable rate interest payments on REMIC regular interests were
published in the Federal Register (59 FR 18746). A notice of proposed
rulemaking (FI-10-94), published in the Federal Register for the same
day (59 FR 18772), cross-references the temporary regulations. That
notice also proposes guidance on whether interest payments on a regular
interest in a REMIC consist of a specified portion of the interest
payments on the qualified mortgages held by the REMIC.
No public hearing was requested or held, but written comments
responding to the notice were received. After consideration of the
comments, the regulations proposed by FI-10-94 are adopted as revised
by this Treasury decision, and the corresponding temporary regulations
are removed.
Explanation of Provisions
Sections 860A through 860G of the Internal Revenue Code set forth
rules for the treatment of REMICs and for the treatment of persons who
hold interests in REMICs. For an entity to qualify as a REMIC, every
interest in the entity must be either a residual interest or a regular
interest.
A. Variable Rates
Section 860G(a)(1)(B)(i) requires that any interest payments on a
regular interest be payable based on a fixed rate, or on a variable
rate to the extent provided in regulations. Regulations providing
guidance under section 860G(a)(1)(B)(i) are included in a comprehensive
set of final regulations relating to REMICs (the 1992 REMIC
regulations), which was published in the Federal Register for December
24, 1992 (57 FR 61293).
The 1992 REMIC regulations use a building-block approach to
describe the permitted variable rates under section 860G(a)(1)(B)(i). A
taxpayer must start with one permitted variable rate as a base and, if
desired, may subject the rate to additions, subtractions,
multiplications, caps, and floors. Under Sec. 1.860G-1(a)(3)(i) of the
1992 REMIC regulations, a permitted variable rate includes a rate that
is a qualifying variable rate for purposes of sections 1271 through
1275 and the related regulations.
[[Page 42786]]
Notice 93-11, 1993-1 C.B. 298, addresses the application of the
term qualifying variable rate. The notice provides that a qualified
floating rate set at a current value (as defined in proposed
regulations under section 1275 (FI-189-84)) is a qualifying variable
rate for purposes of Sec. 1.860G-1(a)(3)(i) of the 1992 REMIC
regulations. Notice 93-11 also states that the 1992 REMIC regulations
will be amended to conform to the language of the final section 1275
regulations when those regulations become effective. After the section
1275 regulations were revised and published in final form in the
Federal Register for February 2, 1994 (59 FR 4799, 4827), the temporary
regulations (TD 8534) and the proposed regulations (FI-10-94) were
issued to conform Sec. 1.860G-1(a)(3)(i) of the 1992 REMIC regulations
to the final section 1275 regulations.
The final section 1275 regulations define two types of variable
rates. Section 1.1275-5(b) defines a qualified floating rate, and
Sec. 1.1275-5(c) defines an objective rate. Under proposed Sec. 1.860G-
1(a)(3)(i) and Sec. 1.860G-1T(a), permitted variable rates for regular
interests in REMICs include a qualified floating rate. Objective rates,
however, are not permitted.
One commentator proposes that the final version of Sec. 1.860G-
1(a)(3)(i) be expanded to include as a permitted variable rate any
objective rate that relates to one or more debt instruments (excluding
any debt instrument that provides for payments measured in substantial
part by reference to the value of property other than debt
instruments). This would allow, for example, a rate equal to the total
rate of return on a bond, or group of bonds.
Many objective rates reflect the returns on equities and
commodities. The IRS and Treasury believe that proposed Sec. 1.860G-
1(a)(3)(i) draws a sensible and necessary line between rates tied to
interest rates (that is, qualified floating rates), and rates tied to
commodities and equities. Moreover, the building-block approach adopted
by the 1992 REMIC regulations affords taxpayers considerable
flexibility to devise permitted variable rates, and the building-block
approach would continue to apply after adoption of the proposed
regulations. The rule in the temporary and proposed regulations,
therefore, is retained in the final regulations under Sec. 1.860G-
1(a)(3)(i).
Retaining Sec. 1.860G-1(a)(3)(i) as proposed affects a cross
reference contained in Sec. 1.860G-1(a)(3)(ii)(A). Commentators suggest
revising Sec. 1.860G-1(a)(3)(ii)(A) to modify the restrictions imposed
by the cross reference in that section to Sec. 1.860G-1(a)(3), which
reference incorporates proposed Sec. 1.860G-1(a)(3)(i). Section 1.860G-
1(a)(3)(ii)(A) permits a REMIC regular interest to have an interest
rate based on a weighted average of the interest rates on some or all
of the mortgages held by the REMIC (a passthrough rate). A mortgage
taken into account in determining a passthrough rate (an underlying
mortgage) must itself have a fixed rate or a permitted variable rate.
Accordingly, a mortgage based on a qualified floating rate may be used
to determine a passthrough rate but the underlying mortgage must
conform to proposed Sec. 1.860G-1(a)(3)(i). This means the qualified
floating rate must be set at a current value. A qualified floating rate
is not set at a current value if it is set more than 3 months before
the start of the related accrual period on the underlying mortgage. The
commentators suggest loan servicers may need more than 3 months to
compute revised interest and payment amounts and to tell borrowers of
those revised amounts. Thus, according to the commentators, the 3-month
period should be extended.
As noted above, the IRS and Treasury believe proposed Sec. 1.860G-
1(a)(3)(i) sensibly distinguishes interest rate returns from other
types of returns. For regular interests having a passthrough rate to
reflect this distinction, any underlying mortgage based on a qualified
floating rate that is used to determine the passthrough rate must also
reflect this distinction. Thus, any underlying mortgage bearing
interest at a qualified floating rate must have the rate set at a
current value. Otherwise, proposed Sec. 1.860G-1(a)(3)(i) could be
circumvented merely by creating a passthrough rate based on underlying
mortgages bearing qualified floating rates not set at current values.
Moreover, the ability of servicers to take more time to calculate
revised rates and to notify borrowers of those rates appears to be
limited by the Truth in Lending Act and Regulation Z (12 CFR Ch. 11
Sec. 226.20(c) (1995)), which require notice, within prescribed time
periods, to a consumer of changes in a rate. Thus, this comment is not
adopted here.
B. Specified Portions
Under section 860G(a)(1)(B)(ii), interest payments on a regular
interest in a REMIC may also consist of a specified portion of the
interest payments on the qualified mortgages held by the REMIC,
provided the specified portion does not vary while the regular interest
is outstanding. A specified portion regular interest is sometimes
called an Interest Only regular interest or IO. The 1992 REMIC
regulations identify the specified portions permitted under section
860G(a)(1)(B)(ii).
Requests for further guidance prompted the publication of the
proposed regulations addressing specified portions. Taxpayers requested
the IRS clarify that a REMIC may issue an IO that is expressed as a
percentage of the interest payable on an IO acquired from another REMIC
(a collateral IO). In response, the notice of proposed rulemaking (FI-
10-94) would add Sec. 1.860G-1(a)(2)(i)(D), under which the cash flows
from a collateral IO issued by one REMIC can be proportionately divided
through another REMIC. The proposed provision would negate the need for
any other arrangement such as a grantor trust and would apply whether
the collateral IO is acquired on formation by a related upper-tier
REMIC or after formation by an unrelated REMIC (a re-REMIC
transaction).
According to one commentator, the addition of Sec. 1.860G-
1(a)(2)(i)(D) implies that more complex re-REMIC transactions are not
allowed. According to another commentator, the language of the proposed
rule implies that all qualified mortgages held by the REMIC must be IO
regular interests. To remove both of those implications, the proposed
rule is adopted in revised form, which appears as Sec. 1.860G-
1(a)(2)(v).
C. Other Comments
Commentators also addressed other REMIC regulations not affected by
this Treasury decision. Those comments may be considered in future
guidance projects.
Special Analyses
It has been determined that this Treasury decision is not a
significant regulatory action as defined in EO 12866. Therefore, a
regulatory assessment is not required. It also has been determined that
section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5)
and the Regulatory Flexibility Act (5 U.S.C. chapter 6) do not apply to
these regulations, and, therefore, a Regulatory Flexibility Analysis is
not required. Pursuant to section 7805(f) of the Internal Revenue Code,
the notice of proposed rulemaking preceding these regulations was
submitted to the Small Business Administration for comment on its
impact on small business.
Drafting Information. The principal authors of these regulations
are Marshall Feiring, Office of Assistant Chief Counsel (Financial
Institutions and Products), and Carol A. Schwartz, formerly of that
office. However, other personnel from the IRS and
[[Page 42787]]
Treasury Department participated in their development.
List of Subjects in 26 CFR Part 1
Income taxes, Reporting and recordkeeping requirements.
Adoption of Amendments to the Regulations
Accordingly, 26 CFR part 1 is amended as follows:
PART 1--INCOME TAXES
Paragraph 1. The authority citation for part 1 is amended by
removing the entry for ``Section 1.860G-1T'' to read in part as
follows:
Authority: 26 U.S.C. 7805 * * *
Par. 2. Section 1.860A-0 is amended by:
1. Adding entries for Sec. 1.860A-1(b)(4).
2. Revising the entry for Sec. 1.860G-1(a)(2)(v).
3. Adding an entry for Sec. 1.860G-1(a)(2)(vi).
4. Revising the entry for Sec. 1.860G-1(a)(3)(i).
The additions and revisions read as follows:
Sec. 1.860A-0 Outline of REMIC provisions.
* * * * *
Sec. 1.860A-1 Effective dates and transition rules.
* * * * *
(b) * * *
(4) Rate based on current interest rate.
(i) In general.
(ii) Rate based on index.
(iii) Transition obligations.
* * * * *
Sec. 1.860G-1 Definition of regular and residual interests.
(a) * * *
(2) * * *
(v) Specified portion includes portion of interest payable on
regular interest.
(vi) Examples.
(3) * * *
(i) Rate based on current interest rate.
* * * * *
Par. 3. In Sec. 1.860A-1, paragraph (b)(4) is added to read as
follows:
Sec. 1.860A-1 Effective dates and transition rules.
* * * * *
(b) * * *
(4) Rate based on current interest rate--(i) In general. Section
1.860G-1(a)(3)(i) applies to obligations (other than transition
obligations described in paragraph (b)(4)(iii) of this section)
intended to qualify as regular interests that are issued on or after
April 4, 1994.
(ii) Rate based on index. Section 1.860G-1(a)(3)(i) (as contained
in 26 CFR part 1 revised as of April 1, 1994) applies to obligations
intended to qualify as regular interests that--
(A) Are issued by a qualified entity (as defined in Sec. 1.860D-
1(c)(3)) whose startup date (as defined in section 860G(a)(9) and
Sec. 1.860G-2(k)) is on or after November 12, 1991; and
(B) Are either--
(1) Issued before April 4, 1994; or
(2) Transition obligations described in paragraph (b)(4)(iii) of
this section.
(iii) Transition obligations. Obligations are described in this
paragraph (b)(4)(iii) if--
(A) The terms of the obligations and the prices at which the
obligations are offered are fixed before April 4, 1994; and
(B) On or before June 1, 1994, a substantial portion of the
obligations are transferred, with the terms and at the prices that are
fixed before April 4, 1994, to investors who are unrelated to the
REMIC's sponsor at the time of the transfer.
Par. 4. Section 1.860G-1 is amended by:
1. Redesignating paragraph (a)(2)(v) as paragraph (a)(2)(vi).
2. Adding a new paragraph (a)(2)(v).
3. Revising paragraph (a)(3)(i).
The addition and revisions read as follows:
Sec. 1.860G-1 Definition of regular and residual interests.
(a) * * *
(2) * * *
(v) Specified portion includes portion of interest payable on
regular interest. (A) The specified portions that meet the requirements
of paragraph (a)(2)(i) of this section include a specified portion that
can be expressed as a fixed percentage of the interest that is payable
on some or all of the qualified mortgages where--
(1) Each of those qualified mortgages is a regular interest issued
by another REMIC; and
(2) With respect to that REMIC in which it is a regular interest,
each of those regular interests bears interest that can be expressed as
a specified portion as described in paragraph (a)(2)(i)(A), (B), or (C)
of this section.
(B) See Sec. 1.860A-1(a) for the effective date of this paragraph
(a)(2)(v).
* * * * *
(3) * * *
(i) Rate based on current interest rate. A qualified floating rate
as defined in Sec. 1.1275-5(b)(1) (but without the application of
paragraph (b)(2) or (3) of that section) set at a current value, as
defined in Sec. 1.1275-5(a)(4), is a variable rate. In addition, a rate
equal to the highest, lowest, or average of two or more qualified
floating rates is a variable rate. For example, a rate based on the
average cost of funds of one or more financial institutions is a
variable rate.
* * * * *
Sec. 1.860G-1T [Removed]
Par. 5. Section 1.860G-1T is removed.
Margaret Milner Richardson,
Commissioner of Internal Revenue.
Approved: July 31, 1995.
Leslie Samuels,
Assistant Secretary of the Treasury.
[FR Doc. 95-20319 Filed 8-16-95; 8:45 am]
BILLING CODE 4830-01-U