Rev. Rul. 84-10

ISSUE

What are the federal income tax consequences associated with the mortgage pool trusts described below?

FACTS

The Federal National Mortgage Association (FNMA) is a publicly held corporation established to provide assistance to the secondary market for home mortgage loans. FNMA has initiated a guaranteed mortgage pass-through securities program under Federal National Mortgage Association Charter Act section 304(d), 12 U.S.C.A. section 1719(d) (West 1980). Pursuant to a trust agreement, FNMA creates home mortgage pools and serves as trustee of each pool. Each pool consists of residential mortgages transferred to it by a single mortgage lender, X, in exchange for trust certificates. The trust certificates generally will be sold by X to investors. FNMA charges X a processing fee when it pools mortgages acquired from X.

In the capacity of pool trustee, FNMA collects principal and interest payments on each mortgage and makes monthly distributions to the certificate holders. FNMA receives a fee for its services as trustee consisting of a monthly service charge retained from the interest collected on the mortgages and other compensation including all late payment charges, assumption fees and prepayment penalties collected by FNMA. Pool proceeds are held in noninterest bearing accounts and cannot be reinvested. Neither the trustee nor X has the power to substitute a new mortgage for an original mortgage in the pool, except that within 120 days of the date the pool is established FNMA may require X to replace defective mortgages in the pool. Each of the pools will terminate when all mortgages are liquidated and all proceeds are distributed. FNMA may terminate a pool by purchasing all trust certificates with respect to the pool when the aggregate outstanding principal amount of mortgages in the pool is 10 percent or less of the initial pool principal balance.

FNMA guarantees that the certificate holders will receive timely payment of interest and collection of principal. If a mortgage is in default or if there is a foreclosure on mortgaged property, FNMA has the right to withdraw the mortgage from the pool and deem the mortgage prepaid.

The trust certificates, which are in registered form, state that they represent fractional undivided interests in the mortgage loans, pool proceeds, mortgaged property acquired by foreclosure that has not been withdrawn from the pool, and FNMA's obligation to supplement the pool proceeds to the extent necessary to make distributions.

LAW

The Service has discussed the federal income tax consequences of similar pooling arrangements in Rev. Rul. 71-399, 1971-2 C.B. 433, amplified by Rev. Rul. 81-203, 1981-2 C.B. 137, Rev. Rul. 80-96, 1980-1 C.B. 1. 317, Rev. Rul. 74-300, 1974-1 C.B. 169, Rev. Rul. 74-221, 1974-1 C.B. 365, and Rev. Rul. 72-376, 1972-2 C.B. 647 (concerning mortgage pools established by the Federal Home Loan Mortgage Corporation); Rev. Rul. 70-544, 1970-2 C.B. 6, and Rev. Rul. 70-545, 1970-2 C.B. 7, both modified by Rev. Rul. 74-169, 1974-1 C.B. 147 (concerning mortgage pools guaranteed by the Government National Mortgage Association); and Rev. Rul. 77-349, 1977-2 C.B. 20 (concerning a mortgage pool created by a commercial bank).

HOLDINGS

(1) Each 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.

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

(3) FNMA will recognize ordinary income in the amount of the processing fees charged X for pooling mortages.

(4) 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.

(5) The sale of a trust certificate transfers to the certificate holder a proportionate share of equitable ownership in each of the mortgages in the pool.

(6) X will recognize ordinary income or loss on the sale of its interest in each of the mortgages in the pool (evidenced by the trust certificates) measured by the difference 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.

(7) Certificate holders shall take into account their proportionate share of the mortgage interest and other items of income, including prepayment penalties, assumption fees, and late payment charges, consistent with their methods of accounting.

(8) The certificate holders must also report their proportionate share of the discount income realized on the purchase of each of the mortgages as ordinary income, consistent with their methods 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. Similarly, the rules of section 1232A(a)(1) will apply to the certificate holders' proportionate shares of obligations in the pool that are not obligations described in section 1232A(a)(2)(A) of the Code (relating to any obligation issued by a natural person).

(9) Certificate holders may amortize their proportionate shares of any premium paid to acquire mortgages to the extent allowed by section 171 of the Code. The provisions of section 171 will be applicable to the premium on mortgages in the pool that are issued by a corporation as described in section 171(d) of the Code.

(10) Certificate holders may deduct their proportionate share of FNMA's fee for servicing the mortgages comprised of the monthly service charge, late payment charges, assumption fees, and prepayment penalties under section 162 or section 212 of the Code, consistent with their method of accounting.

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

(12) 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.

(13) 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.

EFFECT ON OTHER REVENUE RULINGS

Rev. Rul. 70-544, 1970-2 C.B. 6, and Rev. Rul. 70-545, 1970-2 C.B. 7, are clarified with respect to the reporting of service fees, assumption fees, prepayment penalties and late charges by the certificate holders.