On April 13, 2020, the United States Treasury Department (“Treasury”) issued Revenue Procedure 2020-26 (the “Guidance”) setting forth safe harbors under which forbearances and related modifications to certain mortgage loans (including residential and commercial mortgages) will not result in a real estate mortgage investment conduits (“REMICs”) or an investor trust losing its tax favored status provided that the forbearance and/or modification arises from a forbearance program created by the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”) or similar forbearance programs related to the coronavirus pandemic.

CARES Act Background

The CARES Act provides that borrowers of certain federally backed mortgage loans experiencing a financial hardship directly or indirectly arising from the national emergency declared by the President on March 27, 2020 in response to the novel coronavirus disease (the “COVID-19 Emergency”) may request and obtain forbearance on such loans. Forbearance is available from March 27, 2020 through the earlier of the end of the COVID-19 Emergency or December 31, 2020 (the “Covered Period”). Specifically, the CARES Act provides for the following forbearance programs:

• Single-Family Borrower Forbearance: Upon a request for forbearance by a borrower with a federally backed mortgage loan secured by a residential real property designed for the occupancy of 1-4 families who is experiencing financial hardship due to the COVID-19 Emergency (a “Single-Family Borrower”), the borrower’s loan servicer is required to provide forbearance for up to 180 days, with a potential extension for an additional 180 days at the request of the borrower (provided such request is made within the Covered Period).
• Multifamily Borrower Forbearance: Upon a request from a borrower with a federally backed mortgage loan secured by residential property designed principally for the occupancy of 5 or more families who is experiencing a COVID-19 Emergency related financial hardship (a “Multifamily Borrower”), the borrower’s loan servicer is required to (i) document the financial hardship and (ii) provide forbearance for up to 30 days, with a potential extension for 2 additional 30 day periods.

In addition, to the forbearance programs offered by the CARES Act, Treasury expects loan holders and servicers of federally backed and non-federally backed mortgage loans (including commercial loans) not covered by the provisions of the CARES Act will either voluntarily, or through state-mandated loan programs offer similar forbearance programs to borrowers affected by a COVID-19 Emergency related financial hardship. These non-CARES Act forbearance programs may cover residential, commercial and other mortgages and are anticipated to include modifications related to forbearance, such as (i) the addition of deferred payments to the principal amount of the loan due after the original maturity date or (ii) the reamortization of an amortizing loan after the original maturity date.

REMIC Background

REMICs are a common securitization vehicle used for investment in mortgage loans. Provided that certain requirements are satisfied, a REMIC is taxed as a pass-through entity. To be treated as a REMIC for income tax purposes, an entity must (among other requirements) satisfy the following requirements:

• Equity interests of the REMIC may consist only of one or more classes of “regular interests” and a single class of “residual interests;”[1]
• The terms of the regular interests must be fixed on the “startup day” of the REMIC;[2]
• Payments of principal on the regular interests may not be contingent[3] except for contingencies affecting payment of principal due to defaults on qualified mortgage loans, unanticipated expenses of the REMIC or lower than expected returns on permitted REMIC investments;[4]
• The assets of the REMIC must consist of no more than 1% (calculated by adjusted bases of assets) assets that are not qualified mortgages or “permitted investments;”[5]
  • If a REMIC has the power to cause a “significant modification” of a mortgage asset (i.e., a deemed exchange of the original debt instrument for a new debt instrument) (a “Modification”) such mortgage assets will not be treated as a qualified mortgage.[6]
  • A “permitted investment” includes (i) cash flow investment; (ii) qualified reserves and (iii) “foreclosure property.” Foreclosure property does not include loans acquired by the REMIC if the REMIC had an intent to foreclose the loan or the REMIC knew or had reason to know that default would occur.[7]

In addition, a REMIC is subject to a 100% tax on the proceeds of any “prohibited transaction” (a “Prohibited Transaction”).[8] The disposition of a qualified mortgage is treated as a Prohibited Transaction unless such disposition is pursuant to (i) the substitution of a qualified replacement mortgage for a qualified mortgage; (ii) a disposition incident to foreclosure, default, or imminent default of a qualified mortgage; (iii) the bankruptcy or insolvency of the REMIC; (iv) a qualified liquidation of the REMIC; (v) prevention of default on a regular interest in the REMIC where the potential default on such regular interest results from a default on one or more qualified mortgages owned by the REMIC or (vi) a clean-up call wherein the REMIC redeems the regular interests prior to maturity.[9] Any other disposition of a qualified mortgage by a REMIC is treated as a Prohibited Transaction resulting in 100% taxation of the net proceeds of such transaction.

REMIC Guidance

Following the enactment of the CARES Act, Treasury received comments questioning whether CARES ACT forbearance (or related modifications) granted to a borrower of a loan held by a REMIC would:

1. Constitute a “deemed exchange” of the loan and therefore constitute a Modification causing such loan to no longer be treated as a “permitted investment;” 
   • Commentators expressed the concern that REMICs with assets consisting of more than 1% loans undergoing forbearance may be treated as owning more than 1% assets that are not qualified mortgages or “permitted investments” and, consequently, may be in jeopardy of losing their tax favored status and subjecting such REMICs to entity level taxation and/or cause the REMICs regular interests to fail to qualify as debt instruments.
2. Constitute a Prohibited Transaction with respect to the REMIC;
3. Create a deemed reissuance of the regular interests of the REMIC;
4. Cause the REMIC to be treated as having “improper knowledge” of an anticipated default of the loan, thereby causing the loan to no longer be treated as a “permitted investment;” or
5. Cause the origination date of the loan to be redetermined, thereby causing the asset mix of the REMIC on its startup date to be redetermined without regard to such loan and potential jeopardizing qualification as a REMIC.

The Guidance contained favorable answers to the above questions provided that the forbearance at issue is within the scope of the Guidance. The Guidance is applicable to (i) forbearances (and all related modifications) of federally backed mortgage loans issued to Single Family Borrowers and Multifamily Borrowers granted under the CARES Act and (ii) forbearances (and all related modifications) granted under any forbearance program offered voluntarily by a mortgage holder or servicer or mandated by a State for borrowers of any federally backed or non-federally backed mortgage loans (including commercial loans) experiencing a financial hardship due to the COVID-19 Emergency during the Covered Period ((i) and (ii) “Covered Forbearances”), (iii) direct or indirect acquisitions by a REMIC of federally backed mortgage loans issued to Single Family Borrowers and Multifamily borrowers with respect to which such borrower has been granted forbearance under the CARES Act; and (iv) direct or indirect acquisitions by a REMIC of any mortgage loans with respect to which forbearance was granted during the Covered Period under a forbearance program offered voluntarily by a mortgage holder or servicer or mandated by a State for borrowers experiencing a financial hardship due to the COVID-19 Emergency ((iii) and (iv) “Covered Acquired Loans”).

In response to the above concerns, the Guidance stipulated that:

1. A Covered Forbearance granted to a loan held by a REMIC will not be treated as a Modification and will not cause such loan to no longer be treated as a “permitted investment” in the hands of the REMIC;
2. A Covered Forbearance granted to a loan held by a REMIC will not be treated as a Prohibited Transaction;
3. A Covered Forbearance granted to a loan held by a REMIC and the acquisition by a REMIC of a Covered Acquired Loan will not result in a deemed reissuance of the regular interests of such REMIC (thereby jeopardizing the treatment of such regular interests as debt instruments for tax purposes);
4. Covered Acquired Loans will be treated as “permitted investments” of a REMIC;
5. A Covered Forbearance of a loan held by a REMIC will not cause the origination date of such loan to be redetermined.

Investment Trust Background

An investment trust is also a securitization vehicle used for investment in mortgage loans. An investment trust is usually formed to facilitate direct investment in the assets of the trust. Much like a REMIC, an investment trust may have multiple classes of ownership interests. An investment trust is treated, for income tax purposes, as a subchapter J trust and is not subject to entity level tax, provided that it meets certain requirements.[10] Among those requirements is a prohibition on the investment trust possessing the “power to vary the investment” of the certificate holders of the trust (the “Power to Vary”). If an investment trust is deemed to have such power, the trust will be subject to corporate level taxation.[11] 

Investment Trust Guidance

Following the enactment of the CARES Act, Treasury received comments questioning whether CARES ACT forbearance (or related modifications) granted to a borrower of a loan held by an investment trust would result in the investment trust being treated as having the Power to Vary and, consequently, subjecting the trust to entity level tax.

The Guidance stipulated that a Covered Forbearance granted to a loan held by an investment trust does not manifest in such trust the Power to Vary. Accordingly, a Covered Forbearance granted to loans held by an investment trust will not jeopardize the tax favored treatment of the trust under the Regulations.

The conclusions set forth by Treasury in the Guidance regarding the tax consequences of coronavirus related forbearances for loans held or acquired by REMICS and investment trusts should be welcomed by the lending industry in the face of the COVID-19 crisis. However, it is likely that more guidance will be forthcoming.

If you have any questions or comments about the foregoing summary of the Amendments, please contact Sabrina Conyers, Wells Hall, or Drew Hermiller who have contributed to the preparation of this Report.