This edition of the REO Advisor examines the parameters of the REO holding or “grace period" and explores the limits of reconstruction projects at REO properties.
Example 1. A REMIC foreclosed on and acquired title to an office building. The foreclosure took place in December, 2015. Immediately after the foreclosure, the borrower filed suit and challenged the validity of the foreclosure. The litigation continued through November, 2017, at which time the special servicer obtained a court decision validating the foreclosure and REMIC’s title to the office building. During the December, 2015 – November, 2017 period, the special servicer was unable to market and sell the office building as no title insurance company would issue an owner’s policy to prospective purchasers without reservation clauses in connection with the pending litigation. Because the REMIC’s title to the REO property was not judicially confirmed until November, 2017, does the special servicer use November, 2017, as the start of the 3-year grace period during which the REMIC can hold REO property rather than the December 2015 foreclosure?
Answer: No. Regardless of the borrower litigation and its adverse effect on the marketability of the REO property, the IRS has taken a hardline approach to these issues. In this case, we believe that December, 2015, would be considered as the start of the 3-year grace period during which the REMIC may hold the REO property. Depending on the circumstances, the REMIC may be able to apply for and receive one (and only one) 3-year extension to this initial grace period. The Regulations provide that the REO property ceases to be “foreclosure property” on the last day of the 3rd tax year following the tax year in which the REMIC took title to the REO property – the so called REO “grace period.” Accordingly, if the REMIC took title to REO property in 2015, the REO grace period will expire at end of 2018 — the end of the 3rd year after the year in which the REMIC took title to the REO property. The current IRS position is that the grace period commences in the year the foreclosure takes place regardless of whether that foreclosure (and the REMIC’s title to the REO property) is subject to a dispute. In addition, the IRS holds the same position when it comes to a borrower’s right of redemption following foreclosure. With respect to redemption rights, the grace period begins in the year when the foreclosure took place even if the borrower has a redemption right that does not expire until sometime after the tax year in which the foreclosure was completed. In the above example, the special servicer should file with the IRS, before October 31, 2018, an extension request seeking the one, and one only, available 3-year extension to the grace period.