PURCHASERS OF DISCOUNT BONDS MAY USE SIMPLIFIED TAX TREATMENT.

SECTION 1. PURPOSE

This revenue procedure provides simplified tax treatment, pursuant to section 1.1286-1T of the temporary Income Tax Regulations, for certain mortgage loans (mortgages) that are stripped bonds under section 1286 of the Internal Revenue Code. See Rev. Rul. 91-46, page ___, this Bulletin.

SEC. 2. BACKGROUND

01 Section 1286(a) of the Code provides that a stripped bond or stripped coupon purchased after July 1, 1982, is treated by the purchaser (or by any person whose basis is determined by reference to the purchaser's basis) as a bond originally issued on the purchase date and having an original issue discount (OID) equal to the excess of (1) the stated redemption price at maturity (or, in the case of a coupon, the amount payable on the due date of the coupon), over (2) the bond's or coupon's ratable share of the purchase price. Sections 1271 through 1275 provide rules for bonds having OID.

02 Section 1286(b)(4) of the Code provides that, for purposes of section 1286(a), a person that strips one or more coupons from a bond and disposes of the bond or coupon is treated as having purchased on the date of the disposition each item retained, for an amount equal to the basis allocated to the item under section 1286(b)(3). Section 1286(b)(3) provides that the basis of the bond and coupons immediately before the disposition is allocated among the items retained and the items disposed of on the basis of their respective fair market values.

03 Under section 1273(a)(3) of the Code, if the OID on a bond is less than one-fourth of 1 percent of the stated redemption price of the bond at maturity, multiplied by the number of complete years to maturity, then the OID is considered to be zero. In appropriate cases, the number of complete years to maturity means the weighted average maturity of the remaining principal payments under the bond.

04 Section 1278(a)(1) of the Code defines the term "market discount bond" as any bond having market discount. Subject to a de minimis rule, section 1278(a)(2) defines "market discount" as the excess of the stated redemption price of the bond at maturity, over the basis of the bond immediately after its acquisition by the taxpayer. Sections 1276 through 1278 provide rules for market discount bonds.

05 Under section 1278(a)(2)(C) of the Code, if the market discount on a bond is less than one-fourth of 1 percent of the stated redemption price of the bond at maturity, multiplied by the number of complete years to maturity (after the taxpayer acquired the bond), then the market discount is considered to be zero. In appropriate cases, the number of complete years to maturity means the weighted average maturity of the remaining principal payments under the bond.

06. Section 1.1286-1T(a) of the temporary regulations provides that, if the OID determined under section 1286(a) with respect to the purchase of a stripped bond or stripped coupon is less than the amount computed under the OID de minimis rule of section 1273 (a) (3), then the amount of OID with respect to that purchase is considered to be zero.

Section 1.1286-1T(b) authorizes the Internal Revenue Service to provide, by publication in the Internal Revenue Bulletin, that certain mortgage loans that are stripped bonds are to be treated as market discount bonds under section 1278. This treatment may be provided for a stripped bond only if, immediately after the most recent disposition referred to in section 1286(b), either (1) the amount of OID is considered to be zero under section 1.1286-1T(a), or (2) the annual stated rate of interest payable on the stripped bond, is no more than 100 basis prints lower than the annual stated rate of interest on the original bond (before any stripping occurred).

07 In Rev. Rul. 91-46, page __, this Bulletin, a taxpayer sold 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.

SEC. 3. SCOPE

01 This revenue procedure applies to a mortgage that is a stripped bond if --

(1) The mortgage is secured by real property;

(2) But for this revenue procedure, the tax treatment of the stripped bond would be governed by section 1286(a) of the Code; and

(3) The stripped bond satisfies the criterion set forth in subsection .02.

02 A stripped and satisfies the criterion of this subsection if, immediately after the most recent disposition referred to in section 1286(b) --

(1) The amount of OID with respect to the stripped bond is considered to be zero under section 1.1286-1T(a) of the temporary regulations; or

(2) The annual stated rate of interest payable on the stripped bond is no more than 100 basis points lower than the annual stated rate of interest payable on the original bond from which it and any other stripped bond or bonds and any stripped coupon or coupons were stripped. (For this purpose, the annual stated rate of interest payable on the stripped bond includes amounts treated as reasonable compensation for purposes of Rev. Rul. 91-46.)

SEC. 4. PROCEDURE

Any purchaser of a stripped bond to which this revenue procedure applies must --

01 Treat the stripped bond as a "market discount bond" described in section 1278(a)(1) of the Code if the bond has market discount within the meaning of section 1278(a)(2) (including the de minimis rule in section 1278(a)(2)(C)); and

02 Treat the stripped bond as having zero OID under section 1286(a).

SEC. 5. APPLICATION

As a consequence of section 4 --

01 If the stripped bond is not subject to an election made under section 1278(b), gain on the disposition of the stripped bond and on any partial principal payment on the stripped bond must be treated under the rules of section 1276.

02 If the stripped bond is not subject to a constant interest rate election made under section 1276(b)(2), accrued market discount on the stripped bond must be determined as otherwise provided in section 1276(b). See also 2 H.R. Conf. Rep. No. 841, 99th Cong., 2d Sess. II-842, 1986-3 (Vol. 4) C.B. 842 (describing a method of computing accrued market discount on market discount bonds the principal of which may be paid in two or more installments).

03 The tax treatment of any stripped coupon that was separated from the mortgage to produce the stripped bond remains unchanged. For example, under sections 1286(b)(4) and 1286(a) of the Code, the stripped coupon is treated as having OID.

SEC. 6. METHOD OF ACCOUNTING

01 IN GENERAL. The tax treatment provided in this revenue procedure is a method of accounting. Thus, if a taxpayer has an existing method of accounting for stripped bonds that are described in section 3 of this revenue procedure and if that method is consistent with the treatment provided in section 4, the taxpayer must continue to use that method.

02 CHANGE IN METHOD. If a taxpayer has an existing method of accounting for stripped bonds that are described in section 3 of this revenue procedure and if that method is not consistent with the treatment provided in section 4, the taxpayer must change its method of accounting in accordance with section 446 and the regulations thereunder. If the taxpayer's existing method is otherwise permissible under section 1286(a), then, in accordance with section 1.446-1(e)(3)(ii) of the regulations, the Commissioner hereby waives the 180-day rule and, in accordance with section 1.446-1(e)(2)(i), the Commissioner hereby grants consent to a taxpayer that requests to change its method of accounting for those bonds to the method provided in this revenue procedure. This consent must be requested on a statement attached to the timely filed return for the first tax year (year of change) ending on or after August 8, 1991.

03 CUT-OFF BASIS. The consent is granted for stripped bonds purchased on or after the first day of the year of change. Because this change is implemented on a "cut-off" basis, no adjustment under section 481(a) is required to prevent amounts from being duplicated or omitted.

04 PROTECTION FOR YEARS PRIOR TO THE YEAR OF CHANGE. If a taxpayer changes its method of accounting under the consent granted in subsection .02, an examining agent may not propose that the taxpayer change the same method of accounting for a year prior to the year of change.

SEC. 7. EFFECTIVE DATE

This revenue procedure is effective August 8, 1991.

DRAFTING INFORMATION

For further information regarding this revenue procedure contact Mark S. Smith on (202) 566-3297 (not a toll-free call).