[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