Rev. Rul. 77-59

Advice has been requested concerning "repurchase agreement" transactions entered into by a real estate investment trust with a bank.

An unincorporated trust, otherwise qualifying as a real estate investment trust under section 856 of the Internal Revenue Code of 1954, occasionally invests in short-term non-real estate investments pending its need for cash in connection with its real estate and mortgage investments. These short-term investments include transactions called "repurchase agreements" which are generally structured as follows: The trust, desiring to invest money for a specified period of time (generally overnight or for not more than several days) at a specified rate of interest, "purchases" from a bank a stated face amount of United States Treasury obligations (or, upon occasion, negotiable certificates of deposit, banker's acceptances, or commercial paper) of a specific description. Simultaneously, the trust agrees to "resell" the obligations to the bank on a fixed date at the "purchase price" plus an agreed amount of interest, the current rate for such obligations.

The transactions are typically evidenced by a confirmation ticket or a set of simultaneously issued confirmation tickets (one confirming the bank's "sale" and the other confirming the bank's "repurchase"). Although the transaction is termed a "sale" and "repurchase" and the confirmation tickets are generally termed "repurchase agreement," possession of the obligations that are the subject of the "repurchase agreement" is not normally transferred to the trust and no formal written agreement of sale and repurchase is executed. No specific security is credited to the trust's account on the bank's books and the United States Treasury obligations are not marked in any manner to indicate that they are owned by anyone other than the bank. The trust neither benefits nor suffers from any change in either the market value of the United States Treasury obligations or the rate of interest paid in respect of loans secured by such obligations. The trust receives interest at the rate specified in the confirmation tickets.

Rev. Rul. 74-27, 1974-1 C.B. 24, concludes that "purchase and resale" agreement transactions entered into by a bank with certain of its customers are loans of money by the bank upon collateral security and such agreements are not purchases by the bank of securities for investment.

Accordingly, the repurchase agreement transactions entered into by the trust are loans to the bank secured by the United States Treasury obligations (or other forms of collateral). Further, the agreed amount of interest received by the trust from the bank qualifies as interest for purposes of section 856(c)(2)(B) of the Code, which requires that at least 90 percent (95 percent for taxable years beginning after December 31, 1979) of the trust's gross income be derived from specified sources, including interest.

Section 856(c)(5)(A) of the Code requires that at the close of each quarter of the taxable year at least 75 percent of the value of the total assets of the real estate investment trust be represented by real estate assets, cash and cash items (including receivables), and Government securities.

In the instant case, since the repurchase agreements are loans, they are assets of the trust. The assets are not the United States Treasury obligations that secure the loans; rather, the assets are the bank's obligations to repay the funds to the trust. The repurchase agreements are not cash or cash items. See Rev. Rul. 72-171, 1972-1 C.B. 208. Nor are they receivables. See section 1.856-2(d)(1)(iii) of the Income Tax Regulations.

Accordingly, the repurchase agreements do not qualify as an asset described in section 856(c)(5)(A) of the Code for purposes of the 75 percent asset test.

In addition, the trust, in entering into the repurchase agreement transactions, is not considered to be holding property primarily for sale to customers in the ordinary course of its trade or business within the meaning of section 856(a)(4) of the Code, as in effect prior to the enactment of the Tax Reform Act of 1976, section 1603(a), Pub. L. No. 94-455, 94th Cong., 2d Sess. (October 4, 1976). See Rev. Rul. 75-141, 1975-1 C.B. 195, and Rev. Rul. 76-356, 1976-2 C.B. 213.

Also, the repurchase agreement transactions are not "prohibited transactions" within the meaning of section 857(b)(6) of the Code.