[Federal Register Volume 68, Number 214 (Wednesday, November 5, 2003)]
[Proposed Rules]
[Pages 62549-62553]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 03-27866]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[REG-146692-03]
RIN 1545-BC59


Mortgage Revenue Bonds

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking and notice of public hearing.

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SUMMARY: This document contains proposed regulations that provide 
guidance regarding the limitation on the effective rate of mortgage 
interest for purposes of mortgage revenue bonds issued by State and 
local governments. This document also contains a notice of public 
hearing on these proposed regulations.

DATES: Written or electronic comments must be received by January 7, 
2004. Outlines of topics to be discussed at the public hearing 
scheduled for January 28, 2004, at 10 a.m., must be received by January 
7, 2004.

ADDRESSES: Send submissions to CC:PA:LPD:PR (REG-146692-03), room 5203, 
Internal Revenue Service, POB 7604, Ben Franklin Station, Washington, 
DC 20044. Submissions may be hand delivered Monday through Friday 
between the hours of 8 a.m. and 4 p.m. to CC:PA:LPD:PR (REG-146692-03), 
Courier's Desk, Internal Revenue Service, 1111 Constitution Avenue, 
NW., Washington, DC. Alternatively, taxpayers may submit comments 
electronically to the IRS Internet site at http://www.irs.gov/regs. The 
public hearing will be held in the Auditorium,

[[Page 62550]]

Internal Revenue Building, 1111 Constitution Avenue, NW., Washington, 
DC.

FOR FURTHER INFORMATION CONTACT: Concerning the regulations, Michael P. 
Brewer, (202) 622-3980; concerning submissions of comments, the 
hearing, and requests to be placed on the building access list to 
attend the meeting, Treena V. Garrett, (202) 622-3401 (not toll-free 
numbers).

SUPPLEMENTARY INFORMATION:

Background

    Section 103(a) of the Internal Revenue Code of 1986 (Code) provides 
that, generally, interest on any State or local bond is not included in 
gross income. However, this exclusion does not apply to any private 
activity bond that is not a qualified bond.

A. Mortgage Revenue Bonds

    Section 141(e)(1) provides that a qualified mortgage bond or a 
qualified veterans' mortgage bond (together, mortgage revenue bonds) 
issued under section 143 may be a qualified bond.
    Sections 143(a)(2)(A)(ii) and 143(b) provide, in part, that for an 
issue to be an issue of qualified mortgage bonds or qualified veterans' 
mortgage bonds, respectively, the issue must satisfy the requirements 
of section 143(g). Section 143(g)(1) provides that an issue will meet 
the requirements of section 143(g) if the issue satisfies the 
requirements of section 143(g)(2) and, in the case of an issue 95 
percent or more of the net proceeds of which are to be used to provide 
residences for veterans, if the issue satisfies the requirements of 
section 143(g)(3).
    Section 143(g)(2)(A) provides that an issue will meet the 
requirements of section 143(g)(2) only if the excess of (1) the 
effective interest rate on the mortgages provided under the issue, over 
(2) the yield on the issue, is not greater than 1.125 percentage 
points.
    Section 143(g)(2)(B)(i) provides that in determining the effective 
rate of interest on any mortgage for purposes of section 143(g)(2), all 
fees, charges, and other amounts borne by the mortgagor that are 
attributable to the mortgage or the bond issue are taken into account.
    Section 143(g)(2)(B)(ii) provides that, for purposes of determining 
the effective rate of mortgage interest, the following items (among 
others) shall be treated as borne by the mortgagor: (1) All points or 
similar charges paid by the seller of the property; and (2) the excess 
of the amounts received from any person other than the mortgagor by any 
person in connection with the acquisition of the mortgagor's interest 
in the property over the usual and reasonable acquisition costs of a 
person acquiring like property when owner-financing is not provided 
through the use of mortgage revenue bonds.
    Section 143(g)(2)(B)(iii) provides that, for purposes of 
determining the effective rate of mortgage interest, the following 
items shall not be taken into account: (1) Any expected rebate of 
arbitrage profits; and (2) any application fee, survey fee, credit 
report fee, insurance charge, or similar amount to the extent such 
amount does not exceed amounts charged in such area in cases when 
owner-financing is not provided through the use of mortgage revenue 
bonds. The exclusion for application fees, survey fees, credit report 
fees, insurance charges, or similar amounts does not apply to 
origination fees, points, or similar amounts.
    In the case of an issue 95 percent or more of the net proceeds of 
which are to be used to provide residences for veterans, section 
143(g)(3) provides that certain earnings on nonpurpose investments must 
either be paid or credited to mortgagors, or paid to the United States, 
in certain circumstances.
    In the Tax Reform Act of 1986, Pub. L. No. 99-514 (the 1986 Act), 
Congress reorganized sections 103 and 103A of the Internal Revenue Code 
of 1954 (1954 Code) regarding tax-exempt bonds into sections 103 and 
141 through 150 of the Code. Congress intended that to the extent not 
amended by the 1986 Act, all principles of pre-1986 Act law would 
continue to apply to the reorganized provisions. 2 H.R. Conf. Rep. No. 
841, 99th Cong., 2d Sess. II-686 (1986), 1986-3 (Vol. 4) C.B. 686.
    Interpreting section 103A(i)(2)(B)(iii) of the 1954 Code, which is 
substantially identical to section 143(g)(2)(B)(iii) of the Code, Sec.  
6a.103A-2(i)(2)(ii)(C) of the Temporary Income Tax Regulations provides 
the following: ``For example, amounts paid for FHA, VA, or similar 
private mortgage insurance on an individual's mortgage need not be 
taken into account so long as such amounts do not exceed the amounts 
charged in the area with respect to a similar mortgage that is not 
financed with qualified mortgage bonds. Premiums charged for pool 
mortgage insurance will be considered amounts in excess of the usual 
and reasonable amounts charged for insurance in cases where owner 
financing is not provided through the use of qualified mortgage 
bonds.'' Pool mortgage insurance is not defined in the regulations.

B. Qualified Guarantees

    Under Sec.  1.148-4(f), for purposes of computing yield on an 
issue, fees paid for a qualified guarantee for the issue are treated as 
additional interest on the issue. In general, a guarantee is a 
qualified guarantee if: (1) As of the date the guarantee is obtained, 
the issuer reasonably expects that the present value of the fees for 
the guarantee will be less than the present value of the expected 
interest savings on the issue as a result of the guarantee; (2) the 
arrangement creates a guarantee in substance; and (3) the fees for the 
guarantee do not exceed a reasonable, arm's-length charge for the 
transfer of credit risk. The regulations provide that the guarantee of 
a loan of proceeds of an issue, as opposed to a guarantee of the issue, 
may constitute a qualified guarantee, but this rule does not apply to 
guarantees of mortgages financed with mortgage revenue bonds.

Explanation of Provisions

A. Pool Mortgage Insurance

    Recently, questions have arisen regarding whether an issuer should 
be required to treat the portion of the interest payments on a pool of 
mortgages used to pay fees for a guarantee of a pass-through security 
backed by the pool of mortgages as an amount borne by the mortgagors 
that must be taken into account in determining the effective rate of 
interest on the mortgages for purposes of section 143(g). Taking the 
guarantee fees into account results in a higher effective rate of 
interest on the mortgages than if the fees were not taken into account.
    The IRS and Treasury Department have determined that the guarantee 
fees should not be treated as amounts borne by the mortgagors that must 
be taken into account in determining the effective rate of interest on 
the mortgages for purposes of section 143(g). An issuer may achieve 
substantially the same result as not taking the guarantee fees into 
account in computing the effective rate of interest on the mortgages by 
substituting a qualified guarantee on the bonds for the guarantee of 
the pool of mortgages. If an issuer does not take the mortgage 
guarantee fees into account in computing the effective rate of interest 
on the mortgages, the difference between the bond yield and the 
effective rate on the mortgages is reduced because the effective rate 
on the mortgages is reduced. A qualified guarantee of the bonds 
accomplishes the same result by increasing bond yield, rather than 
reducing the effective rate of interest on the mortgages. Issuers 
should not be required to change the form of their transactions in 
these circumstances.

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    Accordingly, to the extent the amounts charged for a guarantee of a 
pool of mortgages do not exceed amounts charged in the area in cases 
when owner-financing is not provided through the use of mortgage 
revenue bonds, the proposed regulations provide that such amounts are 
not treated as borne by the mortgagors and are not taken into account 
in determining the effective rate of interest on the mortgages for 
purposes of section 143(g).

B. Proposed Regulations

    The proposed regulations create a new Sec.  1.143(g)-1. The 
proposed regulations provide that an issue satisfies the requirements 
of section 143(g) only if the issue meets the requirements of Sec.  
1.143(g)-1(b) and, in the case of an issue 95 percent or more of the 
net proceeds of which are to be used to provide residences for 
veterans, the issue also meets the requirements of Sec.  1.143(g)-1(c). 
The requirements of section 143(g) and the proposed regulations are 
applicable in addition to the requirements of section 148 and 
Sec. Sec.  1.148-0 through 1.148-11.
    The proposed regulations provide that an issue shall be treated as 
meeting the requirements of Sec.  1.143(g)-1(b) only if the excess of 
(1) the effective rate of interest on the mortgages financed by the 
issue, over (2) the yield on the issue, is not greater over the term of 
the issue than 1.125 percentage points.
    In determining the effective rate of interest on any mortgage, the 
proposed regulations provide that all fees, charges, and other amounts 
borne by the mortgagor that are attributable to the mortgage or to the 
bond issue are taken into account. Such amounts include points, 
commitment fees, origination fees, servicing fees, and prepayment 
penalties paid by the mortgagor.
    The proposed regulations provide that items that are treated as 
borne by the mortgagor and are taken into account in calculating the 
effective rate of interest also include: (1) All points, commitment 
fees, origination fees, or similar charges borne by the seller of the 
property; and (2) the excess of any amounts received from any person 
other than the mortgagor by any person in connection with the 
acquisition of the mortgagor's interest in the property over the usual 
and reasonable acquisition costs of a person acquiring like property 
where owner-financing is not provided through the use of mortgage 
revenue bonds.
    The proposed regulations further provide that the following items 
are not treated as borne by the mortgagor and are not taken into 
account in calculating the effective rate of interest: (1) Any expected 
rebate of arbitrage profit; and (2) any application fee, survey fee, 
credit report fee, insurance charge or similar settlement or financing 
cost to the extent such amount does not exceed amounts charged in the 
area in cases where owner-financing is not provided through the use of 
mortgage revenue bonds.
    With respect to insurance charges, the proposed regulations provide 
that amounts paid for Federal Housing Administration, Veterans' 
Administration, or similar private mortgage insurance on an 
individual's mortgage, or amounts paid for pool mortgage insurance on a 
pool of mortgages, are not taken into account so long as such amounts 
do not exceed the amounts charged in the area with respect to a similar 
mortgage, or pool of mortgages, that is not financed with mortgage 
revenue bonds. Moreover, for this purpose, amounts paid for pool 
mortgage insurance include amounts paid to an entity (for example, the 
Government National Mortgage Association, the Federal National Mortgage 
Association, the Federal Home Loan Mortgage Corporation, or other 
mortgage insurer) to directly guarantee the pool of mortgages financed 
with the bonds, or to guarantee a pass-through security backed by the 
pool of mortgages financed with the bonds.
    The proposed regulations do not provide guidance regarding all 
aspects of the application of section 143(g)(2). The proposed 
regulations provide that to the extent not inconsistent with the 1986 
Act or subsequent law, the provisions of Sec.  6a.103A-2(i)(2) (other 
than paragraphs (i)(2)(i) and (i)(2)(ii)(A) through (C)) apply to 
provide additional rules relating to compliance with the requirement 
that the effective rate of mortgage interest not exceed the bond yield 
by more than 1.125 percentage points.
    The proposed regulations also do not provide guidance regarding the 
application of section 143(g)(3). The proposed regulations provide that 
to the extent not inconsistent with the 1986 Act or subsequent law, the 
provisions of Sec.  6a.103A-2(i)(4) apply to provide guidance regarding 
the application of section 143(g)(3).

Proposed Effective Dates

    The proposed regulations will apply to bonds sold on or after the 
date of publication of final regulations in the Federal Register, that 
are subject to section 143. Issuers may also apply the proposed 
regulations in whole, but not in part, to bonds sold on or after 
November 5, 2003 and before the date of publication of final 
regulations in the Federal Register, that are subject to section 143. 
In addition, issuers may apply the proposed regulations in whole, but 
not in part, to any bonds that are sold before November 5, 2003, and 
subject to section 143. Finally, subject to the applicable effective 
dates for the corresponding statutory provisions, issuers may apply the 
proposed regulations in whole, but not in part, to any bonds that are 
subject to section 103A(i) of the 1954 Code.

Special Analyses

    It has been determined that this notice of proposed rulemaking is 
not a significant regulatory action as defined in Executive Order 
12866. Therefore, a regulatory assessment is not required. It has also 
been determined that section 553(b) of the Administrative Procedure Act 
(5 U.S.C. chapter 5) does not apply to these regulations, and because 
the regulations do not impose a collection of information on small 
entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not 
apply. Pursuant to section 7805(f) of the Code, this notice of proposed 
rulemaking will be submitted to the Chief Counsel for Advocacy of the 
Small Business Administration for comment on its impact on small 
business.

Comments and Public Hearing

    Before these proposed regulations are adopted as final regulations, 
consideration will be given to any written comments that are submitted 
timely (preferably a signed original and eight copies) to the IRS. The 
IRS and Treasury Department request comments on all aspects of the 
proposed regulations. Comments are also requested on the clarity of the 
proposed regulations and how they may be made easier to understand. All 
comments will be available for public inspection and copying.
    A public hearing has been scheduled for January 28, 2004, at 10 
a.m. in the Auditorium, Internal Revenue Building, 1111 Constitution 
Avenue, NW., Washington, DC. Because of access restrictions, visitors 
will not be admitted beyond the lobby more than 30 minutes before the 
hearing starts. For information about having your name placed on the 
building access list to attend the hearing, see the FOR FURTHER 
INFORMATION CONTACT section of this preamble.
    The rules of 26 CFR 601.601(a)(3) apply to the hearing.
    Persons who wish to present oral comments at the hearing must 
submit written comments by January 7, 2004, and submit an outline of 
the topics to

[[Page 62552]]

be discussed and the amount of time to be devoted to each topic by 
January 7, 2004.
    A period of 10 minutes will be allotted to each person for making 
comments.
    An agenda showing the scheduling of the speakers will be prepared 
after the deadline for receiving outlines has passed. Copies of the 
agenda will be available free of charge at the hearing.

Drafting Information

    The principal authors of these regulations are Timothy L. Jones and 
Michael P. Brewer, Office of Associate Chief Counsel (Tax-exempt and 
Government Entities), IRS, and Bruce M. Serchuk, Office of Tax Policy, 
Treasury Department. However, other personnel from the IRS and 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 proposed to be amended as follows:

PART 1--INCOME TAXES

    Paragraph 1. The authority citation for part 1 continues to read in 
part as follows:

    Authority: 26 U.S.C. 7805 * * *

    Par. 2. Section 1.143(g)-1 is added to read as follows:


Sec.  1.143(g)-1  Requirements related to arbitrage.

    (a) In general. Under section 143, for an issue to be an issue of 
qualified mortgage bonds or qualified veterans' mortgage bonds 
(together, mortgage revenue bonds), the requirements of section 143(g) 
must be satisfied. An issue satisfies the requirements of section 
143(g) only if such issue meets the requirements of paragraph (b) of 
this section and, in the case of an issue 95 percent or more of the net 
proceeds of which are to be used to provide residences for veterans, 
such issue also meets the requirements of paragraph (c) of this 
section. The requirements of section 143(g) and this section are 
applicable in addition to the requirements of section 148 and 
Sec. Sec.  1.148-0 through 1.148-11.
    (b) Effective rate of mortgage interest not to exceed bond yield by 
more than 1.125 percentage points--(1) Maximum yield. An issue shall be 
treated as meeting the requirements of this paragraph (b) only if the 
excess of the effective rate of interest on the mortgages financed by 
the issue, over the yield on the issue, is not greater over the term of 
the issue than 1.125 percentage points.
    (2) Effective rate of interest. (i) In determining the effective 
rate of interest on any mortgage for purposes of this paragraph (b), 
there shall be taken into account all fees, charges, and other amounts 
borne by the mortgagor that are attributable to the mortgage or to the 
bond issue. Such amounts include points, commitment fees, origination 
fees, servicing fees, and prepayment penalties paid by the mortgagor.
    (ii) Items that shall be treated as borne by the mortgagor and 
shall be taken into account in calculating the effective rate of 
interest also include:
    (A) All points, commitment fees, origination fees, or similar 
charges borne by the seller of the property; and
    (B) The excess of any amounts received from any person other than 
the mortgagor by any person in connection with the acquisition of the 
mortgagor's interest in the property over the usual and reasonable 
acquisition costs of a person acquiring like property when owner-
financing is not provided through the use of mortgage revenue bonds.
    (iii) The following items shall not be treated as borne by the 
mortgagor and shall not be taken into account in calculating the 
effective rate of interest:
    (A) Any expected rebate of arbitrage profit under paragraph (c) of 
this section; and
    (B) Any application fee, survey fee, credit report fee, insurance 
charge or similar settlement or financing cost to the extent such 
amount does not exceed amounts charged in the area in cases when owner-
financing is not provided through the use of mortgage revenue bonds. 
For example, amounts paid for Federal Housing Administration, Veterans' 
Administration, or similar private mortgage insurance on an 
individual's mortgage, or amounts paid for pool mortgage insurance on a 
pool of mortgages, are not taken into account so long as such amounts 
do not exceed the amounts charged in the area with respect to a similar 
mortgage, or pool of mortgages, that is not financed with mortgage 
revenue bonds. For this purpose, amounts paid for pool mortgage 
insurance include amounts paid to an entity (for example, the 
Government National Mortgage Association, the Federal National Mortgage 
Association (FNMA), the Federal Home Loan Mortgage Corporation, or 
other mortgage insurer) to directly guarantee the pool of mortgages 
financed with the bonds, or to guarantee a pass-through security backed 
by the pool of mortgages financed with the bonds.
    (C) The following example illustrates the provisions of this 
paragraph (b)(2)(iii):

    Example. Housing Authority X issues bonds intended to be 
qualified mortgage bonds under section 143(a). At the time the bonds 
are issued, X enters into an agreement with a group of mortgage 
lending institutions (lenders) under which the lenders agree to 
originate and service mortgages that meet certain specified 
requirements. After originating a specified amount of mortgages, 
each lender issues a ``pass-though security'' (each, a PTS) backed 
by the mortgages and sells the PTS to X. Under the terms of the PTS, 
the lender pays X an amount equal to the regular monthly payments on 
the mortgages (less certain fees), whether or not received by the 
lender (plus any prepayments and liquidation proceeds in the event 
of a foreclosure or other disposition of any mortgages). FNMA 
guarantees the timely payment of principal and interest on each PTS. 
From the payments received from each mortgagor, the lender pays a 
fee to FNMA for its guarantee of the PTS. The amounts paid to FNMA 
do not exceed the amounts charged in the area with respect to a 
similar pool of mortgages that is not financed with mortgage revenue 
bonds. Under this paragraph (b)(2)(iii), the fees for the guarantee 
provided by FNMA are an insurance charge because the guarantee is 
pool mortgage insurance. Because the amounts charged for the 
guarantee do not exceed the amounts charged in the area with respect 
to a similar pool of mortgages that is not financed with mortgage 
revenue bonds, the amounts charged for the guarantee are not taken 
into account in computing the effective rate of interest on the 
mortgages financed with X's bonds.

    (3) Additional rules. To the extent not inconsistent with the Tax 
Reform Act of 1986, Public Law 99-514 (the 1986 Act), or subsequent 
law, Sec.  6a.103A-2(i)(2) (other than paragraphs (i)(2)(i) and 
(i)(2)(ii)(A) through (C)) of this chapter applies to provide 
additional rules relating to compliance with the requirement that the 
effective rate of mortgage interest not exceed the bond yield by more 
than 1.125 percentage points.
    (c) Arbitrage and investment gains to be used to reduce costs of 
owner-financing. As provided in section 143(g)(3), certain earnings on 
nonpurpose investments must either be paid or credited to mortgagors, 
or paid to the United States, in certain circumstances. To the extent 
not inconsistent with the 1986 Act or subsequent law, Sec.  6a.103A-
2(i)(4) of this chapter applies to provide guidance relating to 
compliance with this requirement.
    (d) Effective Dates--(1) In general. Except as otherwise provided 
in this section, Sec.  1.143(g)-1 applies to bonds sold on or after the 
date of publication

[[Page 62553]]

of final regulations in the Federal Register, that are subject to 
section 143. Issuers may apply Sec.  1.143(g)-1, in whole, but not in 
part, to bonds sold on or after November 5, 2003 and before the date of 
publication of final regulations in the Federal Register, that are 
subject to section 143.
    (2) Permissive retroactive application in whole. Except as provided 
in paragraph (d)(4) of this section, an issuer may apply Sec.  
1.143(g)-1, in whole, but not in part, to any bonds that are sold 
before November 5, 2003, and subject to section 143.
    (3) Bonds subject to the Internal Revenue Code of 1954. Except as 
provided in paragraph (d)(4) of this section, and subject to the 
applicable effective dates for the corresponding statutory provisions, 
an issuer may apply Sec.  1.143(g)-1, in whole, but not in part, to any 
bonds that are subject to section 103A(i) of the Internal Revenue Code 
of 1954.
    (4) Special rule for pre-July 1, 1993 bonds. To the extent that an 
issuer applies this section to any bonds pursuant to paragraph (d)(2) 
or (d)(3) of this section, Sec.  6a.103A-2(i)(3) of this chapter also 
applies to the bonds if the bonds were issued before July 1, 1993.

Mark E. Matthews,
Deputy Commissioner for Services and Enforcement.
[FR Doc. 03-27866 Filed 11-4-03; 8:45 am]
BILLING CODE 4830-01-P