Rev. Rul. 77-349

Advice has been requested as to certain of the Federal income tax consequences associated with "straight pass-through" mortgage-backed certificates to various parties under the circumstances described below.

X, a commercial bank, pursuant to a pooling and servicing agreement ("the Agreement"), formed a "pool" of residential mortgage loans by assigning such loans to Y, an unrelated commercial bank, serving as trustee of the "pool". The assignment of mortgage loans included all principal and interest received by X with respect to the mortgage loans after the day of assignment, other than principal and interest due on the day of assignment. X's assignment is without recourse and X's obligations with respect to the mortgage loans is limited to the representations and warranties made by it as well as its servicing obligations, described below, under the Agreement.

The pool consists of 3x mortgage notes representing an aggregate principal amount of mortgage loans of 1,000x dollars each having a loan-to value ratio at origination of 80 percent or less. The stated fixed interest rate on each mortgage note is 8.75 percent simple annual interest.

Concurrent with assignment of mortgage loans, Y delivered to X certificates in exchange for the mortgage loans. The certificates, issued in registered form, represent fractional undivided interests in the "pool" and bear a pass-through rate of interest which represents the 8.75 percent simple annual interest rate on all of the mortgage loans in the pool less X's regular monthly servicing compensation which is reasonable. Interest and principal are payable to certificate holders in monthly installments corresponding to collections by X on the mortgage loans. X immediately sold the certificates to a group of underwriters in a firm commitment underwriting whereby the certificates were resold to investors. The certificate holders included domestic building and loan associations, real estate investment trusts, and individuals. X used the net proceeds from such sale to originate new conventional residential mortgage loans.

Under the Agreement, Y holds and X services the mortgage loans in the "pool". In addition to the compensation for its monthly services, X is entitled to retain as additional servicing compensation prepayment penalties, late payment charges, and assumption fees. X is required to pay the expenses of its servicing activities, including trustee fees to Y and mortgage insurance premiums. X is obligated under the Agreement to collect payments on the mortgage loans and to follow such collection procedures as are customary with respect to its comparable mortgage loans.

The aforementioned mortgage insurance premiums refer to an insurance contract with Z, a domestically incorporated mortgage insurer that is not related to X or Y and is not affiliated with any federal, state, or local government. Z issued a mortgage guaranty insurance policy in an amount equal to 5 percent of the initial aggregate principal balance of the mortgage loans in the "pool," with X designated as beneficiary of the policy as servicer of the mortgage loans on behalf of the certificate holders. The original amount of coverage under the insurance policy will be reduced over the life of the certificates by the aggregate dollar amount of claims paid.

For the duration of the "pool," neither X, Y, nor Z is empowered to reinvest proceeds attributable to the mortgages in the "pool". Similarly, neither X, Y, nor Z is empowered to substitute new mortgages for the original mortgages in the "pool". Y, however, may require X to repurchase mortgages included in the "pool" that do not meet the representations and warranties given by X in its assignment to the "pool."

Based solely on the foregoing facts, certain of the Federal income tax consequences are as follows:

(1) The "pool" will not be considered an association taxable as a corporation, but is classified as a trust of which the certificate holders are the owners under Subpart E of Subchapter J of the Internal Revenue Code of 1954. See Rev. Rul. 61-175, 1961-2 C.B. 128.

(2) Y is the trustee of a grantor trust and will be required to file Form 1041. See section 1.671-4 of the Income Tax Regulations.

(3) Each certificate holder is treated as the owner of an undivided interest in the entire trust (corpus as well as ordinary income). See section 1.671-3(a)(1) of the regulations.

(4) The sale of the mortgage-backed certificates transfers to the certificate holders the pro rata share of their equitable ownership in each of the mortgages in the "pool".

(5) X will recognize ordinary income or loss upon the sale of its interest in each of the mortgages in the "pool" measured by the differences between the proportionate amount of the proceeds realized with respect to the sale of each of the mortgages and its adjusted basis in each of such mortgages.

(6) Each certificate holder using the cash receipts and disbursements method of accounting shall take into account its pro rata share of the mortgage interest and other items of income as and when they are collected by X, including prepayment penalties, assumption fees, and late payment charges.

(7) Each certificate holder using an accrual method of accounting shall take into account the pro rata share of the mortgage interest and other items of income as they become due to X, including prepayment penalties, assumption fees and late payment charges.

(8) The certificate holders must also report their ratable share of the discount income realized on the purchase of each of the mortgages as ordinary income, consistent with their method of accounting. The special rules of section 1232 of the Code will be applicable to the certificate holders' proportionate shares of the discount on any mortgages in the "pool" that are obligations of corporations, or of governments or their political subdivisions, if and to the extent that the other conditions for the application of that section are met.

(9) Certificate holders may deduct their pro rata shares of X's servicing fees including prepayment penalties, late payment charges, and assumption fees collected by X under section 162 or section 212 of the Code consistent with their methods of accounting.

(10) A real estate investment trust that owns a certificate is considered as owning "real estate assets" within the meaning of section 856(c)(5)(A) of the Code, and interest income will be considered "interest on obligations secured by mortgages on real property" within the meaning of section 856(c)(3)(B).

(11) A certificate owned by a domestic building and loan association is considered as representing "loans secured by an interest in real property" within the meaning of section 7701(a)(19)(C)(v) of the Code, provided the real property is (or from the proceeds of the loan will become) the type of real property described in that section of the Code.

(12) A certificate owned by a domestic building and loan association, within the meaning of section 7701(a)(19) of the Code, is considered as representing "qualifying real property loans" within the meaning of section 593(d) provided the real property underlying the mortgages is (or, from the proceeds of the loan, will become) the type of real property described in that section.