Rev. Rul. 58-41

Advice has been requested as to the basis of the stock of the Federal National Mortgage Association purchased by a taxpayer under the circumstances described below and whether amounts paid for the stock, as well as certain fees paid in connection with the sale of the mortgages to the association, constitute items of cost in determining the ordinary gain or loss upon sale of the mortgages.

A mortgage corporation sold a mortgage, in the ordinary course of its business, to the Federal National Mortgage Association. The unpaid balance of the mortgage was 200x dollars. In order to effect the sale, the corporation, in accordance with the provisions of section 303(b) of the Federal National Mortgage Association Charter Act, approved August 2, 1954, 68 Stat. 590, 12 U. S. C. 1716, purchased stock of the association in the amount of 6x dollars. The corporation was also required to pay a marketing fee of 2x dollars in connection with the sale of the mortgage to the association.

The Act approved August 2, 1954, as far as it is pertinent, created a Government corporation known as the "Federal National Mortgage Association" which is a constituent agency of the Housing and Home Finance Agency. One of the purposes of the Act was to establish in the Federal Government a secondary market facility for home mortgages, and the Act provides that the operation of such facility shall be financed by private capital to the maximum extent feasible.

Section 303 of the Act provides that the Secretary of the Treasury shall initially subscribe to all the capital stock of the association. In addition section 303(b) of the Act provides in part:

The Association shall accumulate funds for its capital surplus account from private sources by requiring each mortgage seller to make payments of non-refundable capital contributions equal to not less than 3 per centum of the unpaid principal amount of mortgages therein involved in purchases or contracts for purchase between such seller and the association, or such greater percentage as may from time to time be determined by the association. In addition, the Association may impose charges or fees for its services with the objective that all costs and expenses of its operation should be within its income derived from such operations and that such operation should be fully self-supporting.

Section 303(c) of the Act provides in part:

The Association shall issue, from time to time, to each mortgage seller its common stock (only in denominations of $100 or multiples thereof) evidencing any capital contributions made by the seller pursuant to subsection (b) of this section.

Section 162 of the Internal Revenue Code of 1954 allows as a deduction from gross income all the ordinary and necessary expenses incurred during a taxable year in carrying on any trade or business.

Section 1012 of the Code provides, with certain exceptions not pertinent here, that the basis of property shall be the cost of such property.

The three percent payment provided in section 303(b) of the Act is a capital contribution for which shares of stock in the association are issued and is in addition to other charges or fees (which constitute an item of mortgage cost) that the association might impose for its services to sellers of mortgages. Such payment is not in lieu of the discount at which mortgages might be acquired by the association, but would be in addition to such discount.

In Exposition Souvenir Corporation v. Commissioner, 163 Fed. (2d) 283, all applicants for concessions (including the taxpayer) at the New York World's Fair were required to invest in debenture bonds that were sold to finance the Fair. The taxpayer obtained a concession until the fair closed. Shortly thereafter, the debentures were sold at a loss. The Circuit Court of Appeals for the Second Circuit in affirming the Tax Court of the United States held that the taxpayer had made an investment in the debentures and that these represented capital assets and the loss upon their sale represented a capital loss.

Revenue Ruling 58-40, page 19, this Bulletin, holds, in part, that any gain or loss upon the sale of stock, bonds or other securities which are purchased pursuant to a contract performed by the taxpayer in the regular course of his business or are purchased solely for the purpose of obtaining inventory, under the particular arrangement there described, constitutes ordinary gain or loss, as the case may be, in the year such stock, bonds, or other securities are sold.

The facts in the instant case are closer in principle to those in the Exposition Souvenir Corporation case. The legislative history of the Federal National Mortgage Association Charter Act of 1954 indicates that Congress intended that purchases of stock of the Association are to be treated as investments in the Association. As in the Exposition Souvenir Corporation case, the taxpayer is required to make such an investment and, although investing in these securities may not be his primary motive in acquiring them, they are necessarily held as investments and, as such, must be treated as capital assets.

Since, in accordance with the principles of the Exposition Souvenir case, the stock constitutes a capital asset, the amount paid therefor does not constitute a deductible business expense but must be capitalized. Any gain or loss upon subsequent disposition constitutes a capital gain or loss measured by the difference between the amount received and 6x dollars (the amount paid for the stock). With respect to the gain or loss upon sale of the mortgage to the association, ordinary gain or loss is measured by the difference between the total proceeds of 200x dollars and the basis of the mortgage to the corporation. The marketing fee of 2x dollars constitutes a cost item to be included as part of the basis of the mortgage in determining the ordinary gain or loss upon its sale.

In view of the above, it is held that (1) the payment for the stock must be capitalized and, since the stock is not an inventory item or an item held for sale to customers in the ordinary course of business, may not be valued at the lower of cost or market but must be valued at cost; (2) such stock constitutes a capital asset as defined in section 1221 of the Code and any gain or loss upon its subsequent disposition constitutes a capital gain or loss as the case may be; and (3) any marketing fees paid to the Association by the corporation constitute additional items of mortgage cost to be taken into account in the computation of the ordinary gain or loss upon the sale of the mortgage to the Association.