IRS PROVIDES SAFE HARBOR FOR COMPUTING INTEREST STRIPPED FROM MORTGAGES SOLD ON SECONDARY MARKET.

SECTION 1. PURPOSE

This revenue procedure provides a safe harbor that taxpayers may elect to use in applying section 1286 of the Internal Revenue Code to certain mortgage servicing contracts. When elected, this safe harbor determines the extent to which amounts that a taxpayer is entitled to receive under a mortgage servicing contract represent reasonable compensation for the services provided.

SEC. 2. BACKGROUND

01 In Rev. Rul. 91-46, page ___, this Bulletin, a taxpayer sold mortgage loans (mortgages) and at the same time entered into a contract to service the mortgages for amounts received from interest payments collected on the mortgages. The ruling holds that the mortgages are "stripped bonds" within the meaning of section 1286(e)(2) of the Code if the contract entitles the taxpayer to receive amounts that exceed reasonable compensation for the services to be performed under the contract. The ruling also holds that the taxpayer's rights to receive amounts under the contract are "stripped coupons" within the meaning of section 1286(e)(3) to the extent that they are rights to receive mortgage interest other than as reasonable compensation for the services to be performed.

02 A mortgage servicing contract generally requires the servicer to perform various services. For example, a contract generally requires the servicer to collect the periodic mortgage payments from the mortgagors and remit these payments to the owner of the mortgages. In addition, a contract generally requires the servicer to accumulate escrows, if any, for the payment of insurance and taxes and disburse these funds as the payments come due, to maintain records relating to the mortgages, and to handle delinquency problems.

03 A mortgage servicing contract generally states the servicer's entitlement to receive amounts from interest payments collected on the mortgages as an annual percentage of the outstanding principal balance of the mortgages to be serviced.

04 In addition, a mortgage servicing contract generally entitles the servicer to retain certain other income that it receives in the course of servicing the mortgages, including income earned on principal and interest payments between the time they are collected and the time they are remitted to the owner of the mortgages, income from sources such as fees for late payments, bad checks, insurance, and assumptions with respect to the mortgages, and income earned through the maintenance of escrow accounts.

SEC. 3. SCOPE

This revenue procedure applies only to contracts to service one- to four-unit residential mortgages. This revenue procedure does not apply to contracts to perform services that do not include substantially all of the services described in section 2.02 of this revenue procedure.

SEC. 4. SAFE HARBOR

01 If the safe harbor applies to a mortgage servicing contract, then for purposes of applying section 1286 of the Code and Rev. Rul. 91-46, reasonable compensation for providing services under the contract is deemed to be the sum of: (1) the amounts that the taxpayer is entitled to receive from mortgage interest collections, up to the applicable safe harbor rate set forth in section 4.02 as applied to the outstanding principal balance of the mortgages to be serviced; and (2) the other income described in section 2.04 that the taxpayer is entitled to receive in the course of servicing the mortgages. Any mortgage interest that the taxpayer is entitled to receive in excess of the safe harbor rate is a payment with respect to stripped coupons held by the taxpayer.

02 For purposes of section 4.01, the following annual rates are the safe harbor rates for servicing one- to four-unit residential mortgages: (1) for a conventional, fixed rate mortgage, 0.25 percent; (2) for a mortgage less than one year old that is insured or guaranteed by the Federal Housing Administration, Veterans Administration, or Farmers Home Administration, 0.44 percent; and (3) for any other one- to four-unit residential mortgage, 0.375 percent. However, if the original principal balance of any mortgage was $50,000 or less, the safe harbor rate for servicing that mortgage is 0.44 percent.

03 If all of the mortgages to be serviced under a contract do not qualify for the same safe harbor rate under section 4.02 of this revenue procedure, the safe harbor rate for servicing these mortgages is a weighted average of the safe harbor rates for the individual mortgages. This average is weighted on the basis of the outstanding principal balances of the mortgages at the time the taxpayer enters into the servicing contract.

04 A taxpayer may elect to use the safe harbor for any taxable year and may revoke this election for any later taxable year. An election to use the safe harbor is effective for all taxable years until a taxable year for which it is revoked. If the safe harbor is elected for a taxable year, the safe harbor applies to all contracts, to which this revenue procedure applies (as described in section 3), to service mortgages that the taxpayer sells during the year.

SEC. 5. METHOD OF ELECTION OR REVOCATION

To elect or revoke the safe harbor, a taxpayer must attach a statement to its timely filed federal income tax return for the first taxable year for which the safe harbor is elected (or revoked). This attachment must state that the taxpayer is electing (or revoking) the safe harbor for mortgage servicing contracts that is provided by Revenue Procedure 91-50.

SEC. 6. EFFECTIVE DATE

This revenue procedure is effective for tax years ending on or after August 8, 1991.

DRAFTING INFORMATION

The principal author of this revenue procedure is Mark S. Smith of the Office of Assistant Chief Counsel (Financial Institutions and Products). For further information regarding this revenue procedure contact Mr. Smith on (202) 566-3297 (not a toll-free call).