On September 15, 2009, the IRS and the Treasury issued final regulations addressing permitted modifications of commercial mortgage loans held by a REMIC and Revenue Procedure 2009- 45, describing the conditions under which modifications to mortgage loans will not cause the IRS to challenge the tax status or treatment of securitization vehicles that hold the loans.1 The guidance is aimed at providing greater flexibility in working out securitized commercial loans. Below we highlight the important aspects of the guidance.
Final Regulations. Under the REMIC rules, only specified modifications to loans are permitted without triggering adverse tax consequences for the REMIC. The new regulations, effective on or after September 16, 2009, finalize proposed regulations released on November 9, 2007. The new rules expand the list of permitted modifications to include (i) release of a lien on real property that secures a mortgage, (ii) release, substitution, addition or other alteration to the collateral for, a guarantee on, or other form of credit enhancement for a loan, and (iii) a change to a loan from recourse to nonrecourse or from nonrecourse to recourse; provided in each case that the loan continues to be “principally secured” by real property after giving effect to the modification. Under the final regulations, the “principally secured” test generally is met if (i) the fair market value of the real property that secures the loan equals at least 80% of the amount of the loan, or (ii) the fair market value of the real property that secures the loan immediately after the modification equals or exceeds the fair market value of the real property that secured the loan immediately before the modification. Clause (ii) was not a provision that was in the proposed regulations but was added in the final regulations and is generally intended to provide a more flexible standard.
Revenue Procedure 2009-45. Under regulations, if a modification to the terms of a loan is “occasioned by default or reasonably foreseeable default,” the modification is a permitted modification. The revenue procedure, in general, provides additional guidance for commercial mortgages. Where requirements of the revenue procedure are met, the IRS will not challenge a securitization vehicle’s favorable tax status or tax treatment as a result of loan modifications (including exchanges) even if the modifications would otherwise be impermissible. The key requirement that must be met is that, based on all the facts and circumstances, the holder or servicer of the loan must reasonably believe that there is a significant risk of default on the loan prior to modification. This belief must be based on a “diligent contemporaneous determination of that risk, which may take into account credible written factual representations made by the issuer of the loan if the holder or servicer neither knows nor has reason to know that such representations are false.” While factors include how far in the future the possible default is, and whether the loan is performing, there is no maximum period after which default is per se not foreseeable, and a holder or servicer may reasonably believe that there is a significant risk of default even if the loan is performing. The revenue procedure applies to loan modifications effected on or after January 1, 2008.