[Federal Register Volume 70, Number 98 (Monday, May 23, 2005)]
[Rules and Regulations]
[Pages 29447-29450]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 05-10163]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 9204]
RIN 1545-BC59


Mortgage Revenue Bonds

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

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SUMMARY: This document contains final 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. These regulations provide guidance to State and local 
governments that issue tax-exempt mortgage revenue bonds.

DATES: Effective Date: These regulations are effective May 23, 2005.
    Applicability Date: For dates of applicability, see Sec.  1.143(g)-
1(d) of these regulations.

FOR FURTHER INFORMATION CONTACT: Michael P. Brewer, (202) 622-3980 (not 
a toll-free number).

SUPPLEMENTARY INFORMATION:

Background

    This document amends the Income Tax Regulations (26 CFR part 1) 
under section 143(g) of the Internal Revenue Code by providing rules 
regarding the limitation on the effective rate of mortgage interest for 
purposes of mortgage revenue bonds issued by State and local 
governments. On November 5, 2003, the IRS published in the Federal 
Register a notice of proposed rulemaking (REG-146692-03)(68 FR 
62549)(the proposed regulations). The proposed regulations would add 
Sec.  1.143(g)-1 to provide rules for calculating the effective rate of 
mortgage interest. A public hearing on the proposed regulations was 
scheduled for January 28, 2004. The public hearing was cancelled 
because no requests to speak were received. Written comments were 
received regarding the proposed regulations. After consideration of the 
written comments, the proposed regulations are adopted by this Treasury 
decision without change (other than

[[Page 29448]]

certain clarifying changes to the effective date provisions).

A. Mortgage Revenue Bonds

    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.
    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 
as additional interest paid.
    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, Public Law 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

    Prior to the issuance of the proposed regulations, questions arose 
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.
    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 would 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

[[Page 29449]]

on the mortgages for purposes of section 143(g).

B. Proposed Regulations

    The proposed regulations propose 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).

C. Final Regulations

    All of the public comments expressed support for the proposed 
regulations as proposed, and the proposed regulations are adopted by 
this Treasury decision without change other than certain changes to the 
effective date provisions to reflect that the regulations are being 
issued in final form.

Effective Dates

    The final regulations apply to bonds sold on or after May 23, 2005, 
that are subject to section 143. Issuers may apply the final 
regulations in whole, but not in part, to bonds sold before May 23, 
2005, that are subject to section 143. Subject to the applicable 
effective dates for the corresponding statutory provisions, issuers may 
apply the final regulations, in whole, but not in part, to bonds that 
are subject to section 103A(i) of the Internal Revenue Code of 1954. To 
the extent that an issuer applies the final regulations to bonds that 
were issued before July 1, 1993, Sec.  6a.103A-2(i)(3) also applies.

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 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, 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 authors of these regulations are Timothy L. Jones and 
Michael P. Brewer, Office of Associate Chief Counsel (Tax-exempt and 
Government Entities), IRS. 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

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

PART 1--INCOME TAXES

0
Paragraph 1. The authority citation for part 1 continues to read in 
part as follows:

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

0
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

[[Page 29450]]

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 May 
23, 2005, that are subject to section 143.
    (2) Permissive retroactive application in whole. Except as provided 
in paragraph (d)(4) of this section, issuers may apply Sec.  1.143(g)-
1, in whole, but not in part, to bonds sold before May 23, 2005, that 
are 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 
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 bonds issued before July 1, 1993, Sec.  
6a.103A-2(i)(3) of this chapter also applies to the bonds.

Mark E. Matthews,
Deputy Commissioner for Services and Enforcement.
    Approved: May 12, 2005.
Eric Solomon,
Acting Deputy Assistant Secretary of the Treasury.
[FR Doc. 05-10163 Filed 5-20-05; 8:45 am]
BILLING CODE 4830-01-P