The Treasury Department and Internal Revenue Service issued guidance for financial institutions to treat gains and losses from certain indirect investments in preferred stock of the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac) as ordinary income or loss. Rev. Proc. 2008-64 clarifies that the ordinary income and loss treatment previously made available for financial institutions’ direct investments in Fannie Mae and Freddie Mac preferred stock under the Emergency Economic Stabilization Act of 2008, Div. A of Pub. Law No. 110-343 (EESA) also is now available for certain indirect investments in such stock.

Section 301 of EESA allows financial institutions to treat gain or loss on the sale or exchange of preferred stock of Fannie Mae and Freddie Mac (Qualified Preferred Stock) as ordinary income or loss. This treatment is permitted for Qualified Preferred Stock which was held by the financial institution on September 6, 2008 or which was sold or exchanged by the financial institution on or after January 1, 2008 and before September 7, 2008.

Rev. Proc. 2008-64 recognizes that many banks and other financial institutions have invested indirectly in Qualified Preferred Stock through corporate subsidiaries or adjustable rate preferred interests in trusts that are treated as partnerships for federal income tax purposes. Under the Rev. Proc, ordinary treatment is now available for indirect investments in Qualified Preferred Stock, including gains and losses on:

  • Qualified Preferred Stock recognized by a trust or other entity taxed as a partnership in which the financial institution is a partner 
  • The sale by a financial institution of its interest in a trust or other entity taxed as a partnership that owns Qualified Preferred Stock, where at least 95 percent of the value of the partnership’s assets consists of the Qualified Preferred Stock and cash or cash equivalents 
  • The sale of Qualified Preferred Stock that the financial institution receives as partner in a distribution from a trust or other entity taxed as a partnership, where at least 95 percent of the value of the partnership’s assets consists of the Qualified Preferred Stock and cash or cash equivalents.

Financial institutions may not use ordinary treatment in the foregoing circumstances to the extent that the gain or loss is a result of an increase in the financial institution’s interest in the partnership or Qualified Preferred Stock after September 6, 2008. However, this limitation does not apply to the extent the financial institution’s interest increased as a result of the acquisition of an additional partnership interest which was “transferred basis property” from a financial institution that held such interest on September 6, 2008.

Rev. Proc. 2008-64 provides that ordinary treatment is also available for gains and losses on: 

  • Qualified Preferred Stock owned by a corporate subsidiary of a financial institution, where the assets of the subsidiary are consolidated in the financial institution’s call report filed with federal bank supervisory authorities and the entities file consolidated federal income tax returns 
  • The sale of Qualified Preferred Stock that is “transferred basis property” received by a financial institution from another financial institution in a merger or other acquisition after September 6, 2008. 

The guidance under Rev. Proc. 2008-64 is effective October 29, 2008.