PPIP, unveiled on March 23, 2009, was designed to encourage the creation of markets for so-called “toxic assets” that were at the center of the credit crisis. It represents an effort to encourage the creation of investment funds, capitalized in part by the U.S. government and in part by private investors, to take toxic assets off the balance sheets of ailing financial institutions. The IRS has recently released favorable revenue procedures addressing two potential tax complications that funds, operating under PPIP, may face. The first prevents application of a rule that could impose an entity level tax on PPIP funds, and the second provides a favorable “look through” rule for testing whether a RIC that invests in such funds is adequately diversified for federal income tax purposes.

Revenue Procedure 2009-38, released on August 27, 2009, provides that the IRS will not assert that funds that invest in toxic assets under PPIP are “taxable mortgage pools” (“TMPs”). A TMP, treated as a corporation for federal income tax purposes that is subject to an entity level tax, generally is defined as any entity (other than a real estate mortgage investment conduit (“REMIC”)) (i) substantially all of the assets of which consist of debt obligations and more than 50% of those assets are real estate mortgages, and (ii) that has issued multiple classes of debt, where the payments made on the debt issued are related to the payments received by the entity on its assets. The revenue procedure generally applies to a fund or portion of a fund that holds securities pursuant to PPIP, provided that the government owns a significant equity interest in the fund, and to any entity or portion of an entity that directly or indirectly owns equity interests in such a fund.

Revenue Procedure 2009-42, released on September 9, 2009, provides that, for purposes of meeting prescribed statutory asset diversification requirements,2 a RIC will be treated as if it directly invested in the assets held by the PPIP in which it invests (as determined in accordance with the RIC’s percentage of ownership of the capital interests in the PPIP). The rule is favorable because the RIC gets to count the PPIP assets as separate assets for purposes of testing diversification. The procedure is available if the RIC invests at least 70% of its original assets (including seed capital and net proceeds from an initial public offering) as a partner in one or more PPIPs that hold PPIP toxic assets and that are treated as partnerships for federal income tax purposes and if the entity’s allocable share of each item of the PPIP’s income, gain, loss, deduction, and credit for federal income tax purposes is proportionate to its percentage of ownership of the capital interests in the PPIP.