[Federal Register Volume 74, Number 178 (Wednesday, September 16, 2009)]
[Rules and Regulations]
[Pages 47436-47439]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E9-22215]
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DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Parts 1 and 602
[TD 9463]
RIN 1545-BG77
Modifications of Commercial Mortgage Loans Held by a Real Estate
Mortgage Investment Conduit (REMIC)
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Final regulation.
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SUMMARY: This document contains final regulations that expand the list
of permitted loan modifications to include certain modifications that
are often made to commercial mortgages. Changes to the regulations are
necessary to better accommodate evolving practices in the commercial-
mortgage industry. These changes will affect lenders, borrowers,
servicers, and sponsors of securitizations of mortgages in REMICs.
DATES: Effective Date: These regulations are effective on or after
September 16, 2009.
Applicability Date: For date of applicability, see Sec. 1.860A-
1(b).
FOR FURTHER INFORMATION CONTACT: Diana Imholtz or Susan Thompson Baker
at (202) 622-3930 (not a toll-free number).
SUPPLEMENTARY INFORMATION:
Paperwork Reduction Act
The collection of information contained in this final regulation
has been reviewed and approved by the Office of Management and Budget
in accordance with the Paperwork Reduction Act of 1995 (44 U.S.C.
3507(d)) under control number 1545-2110. The collection of information
in this final regulation is in Sec. 1.860G-2(b)(7). This information
is required in order to show that certain modifications to mortgages
permitted by this final regulation will not cause the modified mortgage
to cease to be a qualified mortgage. The collection of information is
voluntary to obtain a benefit.
An agency may not conduct or sponsor, and a person is not required
to respond to, a collection of information unless it displays a valid
OMB control number.
Books or records relating to a collection of information must be
retained as long as their contents may become material in the
administration of any internal revenue law. Generally, tax returns and
tax return information are confidential, as required by 26 U.S.C. 6103.
Background
This document contains amendments to 26 CFR part 1 under section
860G of the Internal Revenue Code (Code). In Notice 2007-17 (2007-1 CB
748 (March 19, 2007)), the IRS and the Treasury Department requested
input on whether the present REMIC regulations should be amended to
permit additional types of modifications incurred in connection with
commercial mortgage loans. See Sec. 601.601(d)(2)(ii)(b). The IRS and
the Treasury Department received several comments in response to this
request (the Notice 2007-17 Comments). After consideration of the
Notice 2007-17 Comments, the IRS and the Treasury Department published
in the Federal Register (72 FR 63523) on November 9, 2007, proposed
regulations (REG-127770-07) that would expand the list of permitted
loan modifications to include certain modifications that are often made
to commercial mortgages. The IRS and the Treasury Department received
additional comments in response to the proposed regulations (the
Proposed Regulation Comments). A public hearing was requested and was
held on April 4, 2008 (73 FR 12041). After consideration of the
Proposed Regulation Comments, the proposed regulations are adopted as
revised by this Treasury decision.
Summary of Comments and Explanation of Provisions
Except as specifically provided in Sec. 1.860G-2(b)(3), if there
is a significant modification of an obligation that is held by a REMIC,
then the modified obligation is treated as one that was newly issued in
exchange for the unmodified obligation that it replaced. See Sec.
1.860G-2(b)(1). For this purpose, the rules in Sec. 1.1001-3(e)
determine whether a modification is ``significant.'' See Sec. 1.860G-
2(b)(2). Because of when it is treated as having been acquired in the
deemed exchange, a significantly modified obligation generally fails to
be a qualified mortgage. Section 1.860G-2(b)(3), however, contains a
list of modifications that are expressly permitted without regard to
the section 1001 modification rules.
The final regulations expand this list of permitted exceptions to
include changes in collateral, guarantees, and credit enhancement of an
obligation and changes to the recourse nature of an obligation. These
changes are permitted so long as the obligation continues to be
principally secured by an interest in real property. The final
regulations also clarify when a release of a lien on real property
securing a qualified mortgage does not disqualify the mortgage.
The Proposed Regulation Comments included requests for
clarification and recommendations relating to the following: (i) The
lien release rule; (ii) the requirement to retest the collateral value;
(iii) the appraisal requirement; (iv) changes in the nature of an
obligation from nonrecourse to recourse; (v) investment trusts; and
(vi) other proposals set forth in the Notice 2007-17 Comments that were
not included in the proposed regulations.
1. The Lien Release Rule
The proposed regulations would provide that a lien release pursuant
to certain changes in collateral would not cause a qualified mortgage
to cease to be a qualified mortgage on the date the lien is released.
Commentators indicated that, as drafted, the proposed regulations could
be interpreted to prohibit other types of lien releases, including lien
releases that are occasioned by a default or reasonably foreseeable
default under Sec. 1.860G-2(b)(3)(i) and lien releases that are
permitted pursuant to the terms of the mortgage loan and are not
modifications for purposes of Sec. 1.1001-3. In response
[[Page 47437]]
to these comments, the final regulations clarify that a release of a
lien on real property that does not result in a significant
modification under Sec. 1.1001-3 (for example, a release or
substitution of collateral pursuant to the borrower's unilateral option
under the terms of the mortgage loan) is not a release that
disqualifies a mortgage loan, so long as the mortgage continues to be
principally secured by real property after giving effect to any
releases, substitutions, additions, or other alterations to the
collateral. Similarly, the final regulations clarify that a lien
release occasioned by a default or a reasonably foreseeable default is
not a release that disqualifies the mortgage, so long as the
principally-secured test continues to be satisfied.
2. The Requirement To Retest the Collateral Value
Section 1.860G-2(a)(1) of the regulations provides that an
obligation is principally secured by an interest in real property if
the fair market value of the real property that secures the obligation
equals at least 80 percent of the adjusted issue price of the
obligation. The regulations require the 80-percent test to be satisfied
either at the time the obligation was originated or at the time the
sponsor contributes the obligation to the REMIC. After the startup day,
the regulations do not require ongoing satisfaction of the 80-percent
test.
Because certain types of modifications permitted by the proposed
regulations could affect the value of the collateral securing the
mortgage loan, the proposed regulations would require the 80-percent
test to be satisfied at the time the mortgage loan is modified with
respect to changes in collateral, guarantees, and credit enhancement of
an obligation or with respect to changes to the recourse nature of an
obligation. Commentators indicated that retesting should be required
only when the modification could cause a decrease in the value of real
property collateral relative to the mortgage loan amount. For this
reason, commentators further indicated that changes in guarantees,
credit enhancements or the recourse nature of an obligation, as well as
the addition of collateral, do not have the effect of decreasing the
value of the real property securing the mortgage loan and, therefore,
these types of changes should not require retesting.
To ensure that a modified mortgage loan continues to be principally
secured by an interest in real property, the IRS and the Treasury
Department continue to believe that it is appropriate to retest at the
time of the modification. Accordingly, the final regulations retain the
retesting requirement, but amend the proposed standards for satisfying
the principally secured test as described in section 3 in this
preamble. In addition, to provide a more flexible standard for changes
that do not decrease the value of real property securing the mortgage
loan, the final regulations provide an alternative method for
satisfying the principally secured test.
For these types of changes (for example, a change from recourse to
nonrecourse, or vice versa), the final regulations provide that a
modified mortgage loan continues to be principally secured by real
property if the fair market value of the interest in real property that
secures the loan immediately after the modification equals or exceeds
the fair market value of the interest in real property that secured the
loan immediately before the modification. This alternative test is
consistent with the general rule that a decline in the value of
collateral does not cause a mortgage loan to cease to be principally
secured by real property. The final regulations provide an example to
illustrate the application of this alternative method for satisfying
the principally secured test.
The final regulations also require retesting with respect to a lien
release that is not a significant modification for purposes of Sec.
1.1001-3 (for example, a release of real property collateral pursuant
to the borrower's unilateral option under the terms of the mortgage
loan). Here as well, the principally secured test is satisfied if
either the 80-percent test is satisfied based on the current value of
the real property securing the mortgage or the value of the real
property collateral after the modification is no less than the value of
the real property collateral immediately before.
For purposes of retesting with respect to alterations to real
property collateral, the transaction causing the alteration is looked
at in its entirety in determining the value of the real property
collateral. For example, if, as part of an overall plan to make
improvements to real property collateral that secures a mortgage loan,
a borrower demolishes an existing building and constructs a new
building on that real property, the fair market value of the real
property collateral is determined by taking into account both the
demolition of the existing building and the construction of the new
building.
3. The Appraisal Requirement
For purposes of retesting as of the date of modification, the
proposed regulations would require a current appraisal determined by an
independent appraiser. Several commentators indicated that requiring a
formal appraisal in connection with a loan modification is a stricter
standard than is currently required for satisfying the 80-percent test
at the startup day. See Sec. 1.860G-2(a)(3). For a number of business
reasons, commentators indicated that servicers need more flexibility in
complying with this retesting requirement and, therefore, requested
that the proposed regulations be amended to permit servicers to use
other types of reasonable valuation methods.
In response to these comments and to make the retesting requirement
more consistent with the current rules for satisfying the 80-percent
test at the startup day, the final regulations provide that the
principally-secured test will be satisfied if the servicer reasonably
believes that the modified mortgage loan satisfies the 80-percent test
at the time of the modification. The final regulations provide that a
servicer must base a reasonable belief upon a commercially reasonable
valuation method. The final regulations set forth a nonexclusive list
of commercially reasonable valuation methods that can be used by
servicers for retesting purposes. These same commercially reasonable
methods can be used under the alternative test to establish that the
value of the real property collateral immediately after the
modification is no less than the value of the real property collateral
immediately before it.
4. Changes in the Nature of an Obligation From Nonrecourse to Recourse
The final regulations clarify that changes in the nature of an
obligation from nonrecourse (or substantially all nonrecourse) to
recourse (or substantially all recourse) are permitted so long as the
obligation continues to be principally secured by an interest in real
property.
5. Investment Trusts
Section 301.7701-4(c) of the Procedure and Administration
Regulations provides that an investment trust is not classified as a
trust if there is a power under the trust agreement to vary the
investment of the certificate holders. The IRS and the Treasury
Department understand that changes to the terms of commercial mortgage
loans held by investment trusts may raise issues as to whether a
``power to vary'' is present, and commentators recommended that the
scope of the regulation project be expanded to permit investment trusts
to modify
[[Page 47438]]
commercial mortgage loans in the same manner as REMICs. To avoid a
significant delay in the publication of these final regulations, their
scope has not been expanded to include modifications of mortgage loans
held by investment trusts. In a separate notice to be published in the
Internal Revenue Bulletin contemporaneously with these final
regulations, the IRS and the Treasury Department intend to request
comments on this issue.
6. Other Proposals Set Forth in the Notice 2007-17 Comments
In the Proposed Regulation Comments, commentators requested that
the IRS and the Treasury Department reconsider other proposed loan
modifications that were set forth in the Notice 2007-17 Comments but
that were not included in the proposed regulations. For the reasons
indicated in the preamble to the proposed regulations, the IRS and the
Treasury Department determined that the remaining changes requested by
commentators should not be included in the final regulations.
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 this regulation.
It is hereby certified that the collection of information
requirement in this regulation will not have a significant economic
impact on a substantial number of small business entities. This
certification is based on the fact that the REMICs affected by this
regulation will not be classified as small business entities. According
to the Small Business Administration definition of a ``small
business,'' 13 CFR 121.201, a REMIC is classified under Sector 52
(Finance and Insurance), Subsector 525 (Funds, Trusts and Other
Financial Vehicles) under the category ``Other Financial Vehicle'',
NAICS code 525990, and is only considered a small business entity if it
accumulates less than 6.5 million dollars in annual receipts. REMICs
affected by this regulation generally hold pools of commercial mortgage
loans with an average loan size of 18.1 million dollars, and have
greater than 6.5 million dollars in annual receipts. Therefore, a
Regulatory Flexibility Analysis under the Regulatory Flexibility Act (5
U.S.C. chapter 6) is not required.
Pursuant to section 7805(f) of the Internal Revenue Code, the
notice of proposed rulemaking preceding this regulation 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 Diana Imholtz of the
Office of Associate Chief Counsel (Financial Institutions and
Products). Other personnel from the IRS and the Treasury Department
participated, however, in their development.
List of Subjects
26 CFR Part 1
Income taxes, Reporting and recordkeeping requirements.
26 CFR Part 602
Reporting and recordkeeping requirements.
Adoption of the Amendments to the Regulations
0
Accordingly, 26 CFR parts 1 and 602 are amended as follows:
PART 1--INCOME TAXES
0
Paragraph 1. The authority citation for part 1 is amended by adding
entries in numerical order to read in part as follows:
Authority: 26 U.S.C. 7805 * * *.
Section 1.860A-0 also issued under 26 U.S.C. 860G(e).
Section 1.860G-2 also issued under 26 U.S.C. 860G(e). * * *
0
Par. 2. Section 1.860A-0 is amended by revising the entry for Sec.
1.860G-2(a)(8) and adding an entry for Sec. 1.860G-2(b)(7) to read as
follows:
Sec. 1.860A-0 Outline of REMIC provisions.
* * * * *
Sec. 1.860G-2 Other rules.
(a) * * *
(8) Release of a lien on an interest in real property securing a
qualified mortgage; defeasance.
* * * * *
(b) * * *
(7) Test for determining whether an obligation continues to be
principally secured following certain types of modifications.
* * * * *
0
Par. 3. Section 1.860A-1 is amended by adding paragraph (b)(6) to read
as follows:
Sec. 1.860A-1 Effective dates and transition rules.
* * * * *
(b) * * *
(6) Exceptions for certain modified obligations. Paragraphs
(a)(8)(i), (b)(3)(v), (b)(3)(vi), and (b)(7) of Sec. 1.860G-2 apply to
modifications made to the terms of an obligation on or after September
16, 2009.
0
Par. 4. Section 1.860G-2 is amended by:
0
1. Revising paragraphs (a)(8), (b)(3)(iii) and (b)(3)(iv).
0
2. Adding paragraphs (b)(3)(v), (b)(3)(vi) and (b)(7).
The additions and revisions read as follows:
Sec. 1.860G-2 Other rules.
(a) * * *
(8) Release of a lien on an interest in real property securing a
qualified mortgage; defeasance. If a REMIC releases its lien on an
interest in real property that secures a qualified mortgage, that
mortgage ceases to be a qualified mortgage on the date the lien is
released unless--
(i) The REMIC releases its lien in a modification that--
(A) Either is not a significant modification as defined in
paragraph (b)(2) of this section or is one of the listed exceptions set
forth in paragraph (b)(3) of this section; and
(B) Following that modification, the obligation continues to be
principally secured by an interest in real property as determined by
paragraph (b)(7) of this section; or
(ii) The mortgage is defeased in the following manner--
(A) The mortgagor pledges substitute collateral that consists
solely of government securities (as defined in section 2(a)(16) of the
Investment Company Act of 1940 as amended (15 U.S.C. 80a-1));
(B) The mortgage documents allow such a substitution;
(C) The lien is released to facilitate the disposition of the
property or any other customary commercial transaction, and not as part
of an arrangement to collateralize a REMIC offering with obligations
that are not real estate mortgages; and
(D) The release is not within 2 years of the startup day.
* * * * *
(b) * * *
(3) * * *
(iii) Waiver of a due-on-sale clause or a due-on-encumbrance
clause;
(iv) Conversion of an interest rate by a mortgagor pursuant to the
terms of a convertible mortgage;
(v) A modification that releases, substitutes, adds, or otherwise
alters a substantial amount of the collateral for,
[[Page 47439]]
a guarantee on, or other form of credit enhancement for, a recourse or
nonrecourse obligation, so long as the obligation continues to be
principally secured by an interest in real property following the
release, substitution, addition, or other alteration as determined by
paragraph (b)(7) of this section; and
(vi) A change in the nature of the obligation from recourse (or
substantially all recourse) to nonrecourse (or substantially all
nonrecourse), or from nonrecourse (or substantially all nonrecourse) to
recourse (or substantially all recourse), so long as the obligation
continues to be principally secured by an interest in real property
following such a change as determined by paragraph (b)(7) of this
section.
* * * * *
(7) Test for determining whether an obligation continues to be
principally secured following certain types of modifications. (i) For
purposes of paragraphs (a)(8)(i), (b)(3)(v), and (b)(3)(vi) of this
section, the obligation continues to be principally secured by an
interest in real property following the modification only if, as of the
date of the modification, the obligation satisfies either paragraph
(b)(7)(ii) or paragraph (b)(7)(iii) of this section.
(ii) The fair market value of the interest in real property
securing the obligation, determined as of the date of the modification,
must be at least 80 percent of the adjusted issue price of the modified
obligation, determined as of the date of the modification. If, as of
the date of the modification, the servicer reasonably believes that the
obligation satisfies the criterion in the preceding sentence, then the
obligation is deemed to do so. A reasonable belief does not exist if
the servicer actually knows, or has reason to know, that the criterion
is not satisfied. For purposes of this paragraph (b)(7)(ii), a servicer
must base a reasonable belief on--
(A) A current appraisal performed by an independent appraiser;
(B) An appraisal that was obtained in connection with the
origination of the obligation and, if appropriate, that has been
updated for the passage of time and for any other changes that might
affect the value of the interest in real property;
(C) The sales price of the interest in real property in the case of
a substantially contemporary sale in which the buyer assumes the
seller's obligations under the mortgage; or
(D) Some other commercially reasonable valuation method.
(iii) If paragraph (b)(7)(ii) of this section is not satisfied, the
fair market value of the interest in real property that secures the
obligation immediately after the modification must equal or exceed the
fair market value of the interest in real property that secured the
obligation immediately before the modification. The criterion in the
preceding sentence must be established by a current appraisal, an
original (and updated) appraisal, or some other commercially reasonable
valuation method; and the servicer must not actually know, or have
reason to know, that the criterion in the preceding sentence is not
satisfied.
(iv) Example. The following example illustrates the rules of this
paragraph (b)(7).
Example. (i) S services mortgage loans that are held by R, a
REMIC. Borrower B is the issuer of one of the mortgage loans held by
R. The original amount of B's mortgage loan was $100,000, and the
loan was secured by real property X. At the time the loan was
contributed to R, property X had a fair market value of $90,000.
Sometime after the loan was contributed to R, B experienced
financial difficulties such that it was reasonably foreseeable that
B might default on the loan if the loan was not modified.
Accordingly, S altered various terms of B's loan to substantially
reduce the risk of default. The alterations included the release of
the lien on property X and the substitution of real property Y for
property X as collateral for the loan. At the time the loan was
modified, its adjusted issue price was $100,000. The fair market
value of property X immediately before the modification (as
determined by a commercially reasonable valuation method) was
$70,000, and the fair market value of property Y immediately after
the modification (as determined by a commercially reasonable
valuation method) was $75,000.
(ii) The alterations to B's loan are a significant modification
within the meaning of Sec. 1.1001-3(e). The modification, however,
is described in paragraphs (a)(8)(i) and (b)(3) of this section.
Accordingly, the modified loan continues to be a qualified mortgage
if, immediately after the modification, the modified loan continues
to be principally secured by an interest in real property, as
determined by paragraph (b)(7) of this section.
(iii) Because the modification includes the release of the lien
on property X and substitution of property Y for property X, the
modified loan must satisfy paragraph (b)(7)(i) of this section
(which requires satisfaction of either paragraph (b)(7)(ii) or
paragraph (b)(7)(iii) of this section). The modified loan does not
satisfy paragraph (b)(7)(ii) of this section because property Y is
worth less than $80,000 (the amount equal to 80 percent of the
adjusted issue price of the modified mortgage loan). The modified
loan, however, satisfies paragraph (b)(7)(iii) of this section
because the fair market value of the interest in real estate (real
property Y) that secures the obligation immediately after the
modification ($75,000) exceeds the fair market value of the interest
in real estate (real property X) that secured the obligation
immediately before the modification ($70,000). Accordingly, the
modified loan satisfies paragraph (b)(7)(i) of this section and
continues to be principally secured by an interest in real property.
* * * * *
PART 602--OMB CONTROL NUMBERS UNDER THE PAPERWORK REDUCTION ACT
0
Par. 5. The authority citation for part 602 continues to read as
follows:
Authority: 26 U.S.C. 7805.
0
Par. 6. Section 602.101, paragraph (b) is amended by adding the entry
in numerical order to the table to read as follows:
Sec. 602.101 OMB Control numbers.
* * * * *
(b) * * *
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Current OMB
CFR part or section where identified and described control no.
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* * * * *
1.860G-2................................................ 1545-2110
* * * * *
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Approved: September 9, 2009.
Linda M. Kroening,
Acting Deputy Commissioner for Services and Enforcement.
Michael Mundaca,
Acting Assistant Secretary of the Treasury (Tax Policy).
[FR Doc. E9-22215 Filed 9-15-09; 8:45 am]
BILLING CODE 4830-01-P