LOSSES ARE NOT REALIZED WHEN THREE UNRELATED S&Ls ENTER CONCURRENT TRANSACTIONS WHERE EACH PARTY BUYS AND SELLS MORTGAGE LOAN PORTFOLIOS

Rev. Rul. 85-125

ISSUE

Do the taxpayers realize losses from concurrent transfers of a portion of their respective mortgage loan portfolios, under the circumstances described below?

FACTS

In 1980, X, Y, and Z, three unrelated federally chartered savings and loan associations entered into a series of concurrent transactions in which each party "sold" and "purchased", among themselves, a portion of their respective mortgage loan portfolios (the "mortgage pools").

The mortgage pools "sold" and "purchased" by X, Y, and Z consisted of single-family residential, conventional mortgages with the same contract interest rates and the same stated terms to maturity. The average remaining lives as well as the aggregate unamortized principal balances and the aggregate fair market values of the mortgages in each of the mortgage pools were essentially the same at the time of each "sale" and "purchase". The underlying mortgages that made up the pools involved different mortgagors and different collateral, and some of the mortgages were transferred for mortgages located in other parts of the city, county, or state.

In these transactions, X, Y, and Z each transferred a mortgage pool of low-interest bearing mortgages for a substantially similar mortgage pool and paid and received substantially the same amount of cash with the result that there was no change in position. The cash received equalled the fair market value of the mortgage pools, which had substantially declined in value due to the increase in interest rates.

For federal income tax purposes, X, Y, and Z each claimed a loss deduction in 1980 in the amount of the difference between the cash proceeds received and the adjusted basis of its transferred mortgage pool. For financial reporting purposes, the appropriate regulatory agency did not require X, Y, and Z to record a loss.

LAW AND ANALYSIS

Section 1001(a) of the Internal Revenue Code provides that the gain from the sale or other disposition of property shall be the excess of the amount realized there from over the adjusted basis provided in section 1011 for determining gain, and the loss shall be the excess of the adjusted basis provided in such section for determining loss over the amount realized.

Section 1.1001-1(a) of the Income Tax Regulations provides that the gain or loss realized from the conversion of property into cash, or from the exchange of property for other property differing materially either in kind or in extent, is treated as income or as loss sustained.

Section 165(a) of the Code provides, generally, that there shall be allowed as a deduction any loss sustained during the taxable year and not compensated for by insurance or otherwise.

Section 1.165-1(b) of the regulations provides that to be allowable as a deduction under section 165(a), a loss must be evidenced by closed and completed transactions, fixed by identifiable events, and, except as otherwise provided in section 165(h) and section 1.65-1, relating to disaster losses, actually sustained during the taxable year. Only a bona fide loss is allowable. Substance and not mere form shall govern in determining a deductible loss.

Rev. Rul. 81-204, 1981-2 C.B. 157, holds that the exchange of mortgage pools among three unrelated savings and loan associations did not result in a loss because the requirements of section 1.1001-1(a) of the regulations have not been met. The mortgage loan portfolios ("pools") exchanged did not differ materially either in kind or extent. Instead, the mortgage pools exchanged constituted mass or indivisible assets that averaged out the unique characteristics and risks inherent in each constituent mortgage. The existence of different mortgagors and different collateral in the mortgages that made up the mortgage pools did not prevent the aggregation of the mortgages into a mass or indivisible asset.

In this situation, as in Rev. Rul. 81-204, the mortgage pools "sold" and "purchased" by X, Y, and Z possessed sufficient economic correspondence to each other that the mortgage pools cannot be considered as differing materially either in kind or extent from each other, despite the differences in the identities of the individual mortgagors and in the underlying collateral. All three pools consisted of single family residential, conventional mortgages with the same contract interest rate and the same stated terms to maturity. The average remaining lives as well as the aggregate fair market values of the mortgages in each of the three mortgage pools "sold" and "purchased" were substantially the same at the time of the transfers.

The fact that the transactions were structured as "sales" and "purchases" as opposed to "mortgage swap" transactions within the factual setting of Rev. Rul. 81-204 does not alter this conclusion. Rather than separate and distinct transactions, the concurrent "sales" and "purchases" represent component parts of an integrated transaction in which the first step was to "sell" the mortgage pool and the second step was to "acquire" another matched mortgage pool. Thus, after the concurrent "sales" and "purchases" of the mortgage pools, X, Y, and Z were in substantially the same economic position as before these transactions. The transfers of the mortgages and cash did not have independent adequacy. Each part of the transaction was dependent on every other part, and X, Y, and Z were in the same economic position before and after the transaction.

While each taxpayer may have had a business purpose for securing a different portfolio of mortgages, the facts indicate that the "sale" and "purchase" of mortgage pools had no economic purpose or utility apart from the anticipated tax consequences. In each case, the transfer was so hedged, in terms of economic reality, that it cannot be considered to be the closing out of a losing venture. An actual loss is not realized for tax purposes unless when the entire transaction is concluded, the taxpayer has sustained the loss claimed. See Shoenberg v. Commission, 77 F.2d 446 (8th cir. 1935).

HOLDING

Under the circumstances described above, the taxpayers do not realize losses from concurrent transfers of a portion of their respective mortgage loan portfolios.

EFFECT ON OTHER DOCUMENTS

This revenue ruling amplifies Rev. Rul. 81-204 by extending the rationale and holding to a series of concurrent "sales" and "purchases" of mortgage pools by three unrelated savings and loan associations.