Rev. Rul. 70-142

The purpose of this Revenue Ruling is to update and restate, under the current statute and regulations, the position set forth in I.T. 3496, C.B. 1941-2, 107.

M, a domestic bank and trust company, keeps its books and records and reports its income for Federal income tax purposes on the accrual method of accounting. M conducts a commercial and trust banking business, in connection with which it acquired for resale mortgages guaranteed by the Federal Housing Administration. These mortgages are amortized over the lives of the loans. M acquired the mortgages by lending money to the purchasers of houses and then sold the mortgages to investors at par, and entered into an agreement with the purchaser of each mortgage to service the mortgage during its lifetime for a percentage of the unpaid principal. Such servicing includes the collection of principal and interest, payment of taxes and insurance, and inspection of the property. The service charge collected each year is based on the declining balance of the unpaid principal.

The sale and servicing agreement provides, in part, as follows:

Continuously from the date hereof until the principal and interest of the mortgage are paid in full, the servicer will proceed diligently to collect all payments due under the mortgage, as and when the same shall become due and payable, and will promptly discharge all of the obligations of the mortgagee named in the mortgage, as well as every obligation arising hereunder and under the contract of insurance with the Federal Housing Administrator. As full compensation for its services, the servicer will retain, from money collected by it each month an amount equal to--per cent of the outstanding balance as shown by the Federal Housing Administration amortization schedule.

The specific question in the instant case is whether M may compute the total service charge to be received in connection with each mortgage during its entire period, take an average of the amount so computed, and report as income for each year during the life of the mortgage only the average amount of the service charge computed over the life of the mortgage.

Section 451 of the Internal Revenue Code of 1954 provides that all items of gross income shall be reported for the taxable year in which received by the taxpayer, unless under methods of accounting permitted under section 446 of the Code any such amounts are to be properly accounted for as of a different period. Section 446 of the Code provides that income shall be reported in accordance with the method of accounting regularly employed in keeping the books of the taxpayer, but if no such method of accounting has been so employed, or if the method employed does not clearly reflect the income, the computation shall be made in accordance with such method as in the opinion of the Secretary of the Treasury or his delegate does clearly reflect the income.

Section 1.446-1(a)(2) of the Income Tax Regulations provides, in part, that no method of accounting is acceptable unless, in the opinion of the Commissioner, it clearly reflects income. A method of accounting that reflects the consistent application of generally accepted accounting principles in a particular trade or business in accordance with accepted conditions or practices in that trade or business will ordinarily be regarded as clearly reflecting income, provided all items of gross income and expense are treated consistently from year to year.

Section 1.451-1(a) of the regulations provides, in part, that under the accrual method of accounting, income is includible in gross income when all the events have occurred that fix the right to receive such income and the amount thereof can be determined with reasonable accuracy.

In the instant case M entered into an agreement with the purchaser of a mortgage to service the mortgage during its life for a specified percentage of the unpaid principal thereof, which amount it receives monthly without restriction as to its disposition.

Accordingly, it is held that the service fees received by M are includible in its gross income in the year in which received.

I.T. 3496 is hereby superseded, since the position set forth therein is restated under current law in this Revenue Ruling.

¹ Prepared pursuant to Rev. Proc. 67-6, C.B. 1967-1, 576.