[Federal Register Volume 69, Number 91 (Tuesday, May 11, 2004)]
[Rules and Regulations]
[Pages 26040-26042]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 04-10684]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 9128]
RIN 1545-BB73


Real Estate Mortgage Investment Conduits; Application of Section 
446 With Respect to Inducement Fees

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulation.

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SUMMARY: This document contains final regulations relating to the 
proper timing and source of income from fees received to induce 
taxpayers to become the holders of noneconomic residual interests in 
Real Estate Mortgage Investment Conduits (REMICs).

DATES: Effective Date: These regulations are effective May 11, 2004.
    Applicability Dates: For dates of applicability of the final 
regulations, see Sec. Sec.  1.446-6(g) and 1.863-1(f).

FOR FURTHER INFORMATION CONTACT: For information concerning accounting 
for inducement fees relating to noneconomic REMIC residual interests, 
contact John W. Rogers III at (202) 622-3950 (not a toll-free number). 
For information concerning the source of REMIC inducement fee income, 
contact Bethany Ingwalson at (202) 622-3850 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

Background

    This document contains amendments to the Income Tax Regulations (26 
CFR part 1) under sections 446(b)(relating to general rules for methods 
of accounting), 860C (relating to other definitions and special rules 
applicable to REMICs), and 863(a)(relating to special rules for 
determining source) of the Internal Revenue Code of 1986 (Code). On 
July 21, 2003, the IRS and Treasury Department published a notice of 
proposed rulemaking (REG-162625-02) in the Federal Register (68 FR 
43055).
    In the notice of proposed rulemaking the IRS and Treasury 
Department requested comments on the proper method of accounting to be 
used by taxpayers for inducement fee income. No written or electronic 
comments were received from the public in response to the notice of 
proposed rulemaking. No requests to speak at the public hearing were 
received, and, accordingly, the hearing was canceled. Therefore, these 
final regulations adopt without substantive changes the proposed 
regulations set out in the notice of proposed rulemaking.

Explanation of Provisions

    Final regulations governing REMICs, issued in 1992, contain rules 
governing the transfer of noneconomic residual interests. Those 
regulations do not, however, contain rules that address the 
transferee's treatment of the fee received to induce the transferee to 
become the holder of a noneconomic residual interest. Following release 
of the final REMIC regulations, the IRS and the Treasury Department 
received requests for guidance on the proper method of accounting to be 
used by taxpayers for inducement fee income. These regulations provide 
rules relating to the proper timing and source of income from an 
inducement fee received in connection with becoming the holder of a 
noneconomic residual interest in a REMIC.
    The notice of proposed rulemaking published on July 21, 2003, 
stated that, to clearly reflect income, an inducement fee must be 
included in income over a period that is reasonably related to the 
period during which the applicable REMIC is expected to generate 
taxable income or net loss allocable to the holder of the noneconomic 
residual interest. The notice of proposed rulemaking further stated 
that an inducement fee generally may not be taken into account in a 
single tax year. The notice of proposed rulemaking also set forth two 
safe harbor methods of accounting for inducement fees and contained a 
rule clarifying that an inducement fee is income from sources within 
the United States. The final regulations adopt these provisions without 
substantive change. For further information on the rationale for the 
rules set out in these final regulations, see the preamble for the 
proposed regulations in the notice of proposed rulemaking.
    The effective date provision of Sec.  1.446-6(g) contained in the 
notice of proposed rulemaking stated that these regulations would 
become effective upon publication of the final regulations in the 
Federal Register. The notice of proposed rulemaking specifically 
requested comments on whether the applicability of these regulations 
should be limited to transactions arising on or after their effective 
date and whether some delay in the effective date of these regulations 
is warranted. No comments were received from the public in response to 
this request. In finalizing these regulations, the IRS and Treasury 
Department have determined not to limit the applicability of these 
regulations to transactions arising on or after the effective date of 
the final regulations or to delay the effective date. The effective 
date provision in Sec.  1.446-6(g), therefore, is also adopted without 
substantive change.

Special Analyses

    It has been determined that this Treasury decision 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 
these 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, the notice of proposed 
rulemaking preceding these regulations was submitted to the Chief 
Counsel for Advocacy of the Small Business Administration for comment 
on its impact on small business.

Drafting Information

    The principal author of these regulations is John W. Rogers III, 
Office of Associate Chief Counsel (Financial Institutions & Products). 
However, other personnel from the IRS and the 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

0
Accordingly, 26 CFR part 1 is amended as follows:

PART 1--INCOME TAXES

0
Paragraph 1. The authority citation for part 1 is amended by adding an 
entry in numerical order to read, in part, as follows:

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


[[Page 26041]]


    Section 1.446-6 also issued under 26 U.S.C. 446 and 26 U.S.C. 
860G; * * *


0
Par. 2. Section 1.446-6 is added to read as follows:


Sec.  1.446-6  REMIC inducement fees.

    (a) Purpose. This section provides specific timing rules for the 
clear reflection of income from an inducement fee received in 
connection with becoming the holder of a noneconomic REMIC residual 
interest. An inducement fee must be included in income over a period 
reasonably related to the period during which the applicable REMIC is 
expected to generate taxable income or net loss allocable to the holder 
of the noneconomic residual interest.
    (b) Definitions. For purposes of this section:
    (1) Applicable REMIC. The applicable REMIC is the REMIC that issued 
the noneconomic residual interest with respect to which the inducement 
fee is paid.
    (2) Inducement fee. An inducement fee is the amount paid to induce 
a person to become the holder of a noneconomic residual interest in an 
applicable REMIC.
    (3) Noneconomic residual interest. A REMIC residual interest is a 
noneconomic residual interest if it is a noneconomic residual interest 
within the meaning of Sec.  1.860E-1(c)(2).
    (4) Remaining anticipated weighted average life. The remaining 
anticipated weighted average life is the anticipated weighted average 
life determined using the methodology set forth in Sec.  1.860E-
1(a)(3)(iv) applied as of the date of acquisition of the noneconomic 
residual interest.
    (5) REMIC. The term REMIC has the same meaning in this section as 
given in Sec.  1.860D-1.
    (c) General rule. All taxpayers, regardless of their overall method 
of accounting, must recognize an inducement fee over the remaining 
expected life of the applicable REMIC in a manner that reasonably 
reflects, without regard to this paragraph, the after-tax costs and 
benefits of holding that noneconomic residual interest.
    (d) Special rule on disposition of a residual interest. If any 
portion of an inducement fee received with respect to becoming the 
holder of a noneconomic residual interest in an applicable REMIC has 
not been recognized in full by the holder as of the time the holder 
transfers, or otherwise ceases to be the holder for Federal tax 
purposes of, that residual interest in the applicable REMIC, then the 
holder must include the unrecognized portion of the inducement fee in 
income at that time. This rule does not apply to a transaction to which 
section 381(c)(4) applies.
    (e) Safe harbors. If inducement fees are recognized in accordance 
with a method described in this paragraph (e), that method complies 
with the requirements of paragraph (c) of this section.
    (1) The book method. Under the book method, an inducement fee is 
recognized in accordance with the method of accounting, and over the 
same period, used by the taxpayer for financial reporting purposes 
(including consolidated financial statements to shareholders, partners, 
beneficiaries, and other proprietors and for credit purposes), provided 
that the inducement fee is included in income for financial reporting 
purposes over a period that is not shorter than the period during which 
the applicable REMIC is expected to generate taxable income.
    (2) The modified REMIC regulatory method. Under the modified REMIC 
regulatory method, the inducement fee is recognized ratably over the 
remaining anticipated weighted average life of the applicable REMIC as 
if the inducement fee were unrecognized gain being included in gross 
income under Sec.  1.860F-2(b)(4)(iii).
    (3) Additional safe harbor methods. The Commissioner, by revenue 
ruling or revenue procedure (see Sec.  1.601(d)(2) of this chapter), 
may provide additional safe harbor methods for recognizing inducement 
fees relating to noneconomic REMIC residual interests.
    (f) Method of accounting. The treatment of inducement fees is a 
method of accounting to which the provisions of sections 446 and 481 
and the regulations thereunder apply. A taxpayer is generally permitted 
to adopt a method of accounting for inducement fees that satisfies the 
requirements of paragraph (c) of this section. Once a taxpayer adopts a 
method of accounting for inducement fees, that method must be applied 
consistently to all inducement fees received in connection with 
noneconomic REMIC residual interests and may be changed only with the 
consent of the Commissioner, as provided by section 446(e) and the 
regulations and procedures thereunder.
    (g) Effective date. This section is applicable for taxable years 
ending on or after May 11, 2004.

0
Par. 3. Section 1.860A-0 is amended by adding an entry in the outline 
for Sec.  1.860C-1(d) to read as follows:


1.860A-0  Outline of REMIC provisions.

* * * * *


1.860C-1  Taxation of holders of residual interests.

* * * * *
    (d) Treatment of REMIC inducement fees.
* * * * *

0
Par. 4. Section 1.860C-1 is amended by adding paragraph (d) to read as 
follows:


1.860C-1  Taxation of holders of residual interests.

* * * * *
    (d) For rules on the proper accounting for income from inducement 
fees, see Sec.  1.446-6.
* * * * *

0
Par. 5. Section 1.863-0 is amended by:
0
1. Revising the entry for the section heading for Sec.  1.863-1.
0
2. Adding an entry for Sec.  1.863-1(d).
0
3. Redesignating the entry for Sec.  1.863-1(e) as Sec.  1.863-1(f).
0
4. Adding a new entry for Sec.  1.863-1(e).
    The additions and revisions read as follows:


Sec.  1.863-0  Table of contents.

* * * * *


Sec.  1.863-1  Allocation of gross income under section 863(a).

* * * * *
    (d) Scholarships, fellowship grants, grants, prizes and awards.
    (e) REMIC inducement fees.
* * * * *


0
Par. 6. Section 1.863-1 is amended as follows:
0
1. Paragraph (e) is revised.
0
2. Paragraph (f) is added.
    The revision and addition read as follows:


Sec.  1.863-1  Allocation of gross income under section 863(a).

* * * * *
    (e) REMIC inducement fees. An inducement fee (as defined in Sec.  
1.446-6(b)(2)) shall be treated as income from sources within the 
United States.
    (f) Effective dates. The rules of paragraphs (a), (b), and (c) of 
this section apply to taxable years beginning after December 30, 1996. 
However, taxpayers may apply the rules of paragraphs (a), (b), and (c) 
of this section for taxable years beginning after July 11, 1995, and on 
or before December 30, 1996. For years beginning before December 30, 
1996, see Sec.  1.863-1 (as contained in 26 CFR part 1 revised as of 
April 1, 1996). See paragraph (d)(4) of this section for rules 
regarding the applicability date of paragraph (d) of this section. 
Paragraph (e) of this section

[[Page 26042]]

is applicable for taxable years ending on or after May 11, 2004.

Mark E. Matthews,
Deputy Commissioner for Services and Enforcement.
    Approved: May 4, 2004.
Gregory Jenner,
Acting Assistant Secretary of the Treasury.
[FR Doc. 04-10684 Filed 5-7-04; 8:45 am]
BILLING CODE 4830-01-P