Real Estate Mortgages (Portfolio 592)

Real Estate Mortgages, written by Robert W. Wood of Wood & Porter, analyzes the tax consequences of one of the basic financing tools in the field of real estate: the mortgage. 

A real estate mortgage is a means of securing a debt instrument, generally of the taxpayer, with real property. As commonly used, the term “mortgage” refers not only to the mortgage itself but also to the liability it secures. Thus, a real estate mortgage, as a liability, is generally subject to the rules governing liabilities. 

This Portfolio reviews the basic principles, and many of the nuances, of real estate mortgages. Generally, borrowing money secured by real estate is the traditional way in which mortgage debt is created, and the taxpayer certainly knows he is doing it. However, the IRS has occasionally attempted to recast certain sale/leaseback transactions as mere financings by the seller-lessee, with the result that the purchaser/lessor is deprived of anticipated tax benefits. 

This Portfolio explains the effects of a mortgage on property basis. A mortgage can establish basis in property for the mortgagor when it is used to acquire property or it can result in the receipt of tax-free cash to the mortgagor when it is obtained with respect to property already owned.  

This Portfolio also explains the tax treatment of the costs of acquisition, placement, and servicing of a mortgage to both the mortgagor and the mortgagee and the effects of foreclosure of a mortgage on the mortgagor and mortgagee.

Also discussed are the tax consequences to the mortgagee, whether a provider of funds or credit, or a purchaser of the mortgage debt from a prior mortgagee, upon the collection of the mortgage debt or the disposition of the mortgage. 

Real Estate Mortgages allows you to benefit from:

• Hundreds of hours of original research on specific tax planning topics from leading practitioners in this area
• Invaluable practice documents, including tables, charts, and lists
• Plain-English guidance from world-class experts
• Real-world and in-depth analysis that lets you explore various options
• Time-saving access to relevant sections of tax laws, regulations, court cases, IRS documents, and more
• Alternative approaches to both common and unique tax scenarios 

This Portfolio is part of the U.S. Income Portfolios Library, a comprehensive series that includes more than 200 Portfolios, which cover every federal tax topic with expert, in-depth analysis, and offer commentary on a wide range of federal taxation topics, including Compensation Planning, Deductions and Credits, Partnerships and Corporations, Special Pass-Through Entities, Corporate Reorganizations, Real Estate, Procedure and Administration, and more.

Detailed Analysis

I. Introduction

II. Cost of Obtaining a Mortgage Loan

Introductory Material

A. Deductibility of Loan Costs

1. Controversy Over Points

2. Deductibility of Points

B. Further Limitations on Deductibility of Loan Costs

1. Section 263A Uniform Capitalization Rules

2. Nondeductibility of “Pre-Opening” Expenses

3. Fifteen-Year Amortization under Section 195

C. Accelerating Deductions

1. Prepayment of Mortgage Loan

2. Sale of the Property

3. Distribution of Property by a Corporate Mortgagor

4. Renewal or Extension of a Mortgage

III. Tax Rules for Debt and Mortgage Instruments

A. In General

B. Other Transactions Distinguished

1. Interest Paid on “Debt” in Excess of Fair Market Value of Property

2. Interest or Share of Profits

3. Interest as Part of “Sham in Substance”

C. Who Is Entitled to Deduct Interest on Mortgage Debt

1. Joint Ownership

2. Nominee Arrangements

3. Guarantors of Mortgage Debt

D. Interest Deduction - Cash Basis Mortgagor

1. Reverse Mortgage Loans

a. Background

b. Deductibility of Reverse Mortgage Loan Interest

2. Shared Appreciation Mortgages

a. Background

b. Deduction of SAM Interest Payments

c. Treatment of Mortgage REIT SAM Loans

(1) 1997 Changes

(2) Adverse Consequences

E. Limitations on Deductibility of Mortgage Interest

1. Capitalization of Interest - Section 263A(f)

2. Alternative Minimum Tax

F. Limitations on Deductibility of Non-Capitalized Interest

1. Interest on Mortgage Debt Allocated to Passive Activities

2. Investment Interest

3. Limitations on Deduction of Residential Mortgage Interest

a. Qualified Residence Interest

b. Residential Mortgage Interest and Vacation Homes

c. Price Level Adjusted Mortgage (PLAM)

4. Mortgage Interest on Debt Financed Partnership Distributions

G. Cost of Retiring Mortgage Debt and Assumptions/Modifications

1. Prepayment Penalties

2. Attorneys Fees, etc.

3. Assumptions

4. Modifications

H. Mortgage Revenue Bonds

1. Income Limitations

2. Purchase Price Requirements

3. Status of Recipient as First Time Home Buyer

4. Veterans Programs

I. Mortgage Credit Certificates

1. General Rules

2. Reporting Requirements

a. Lenders

(1) Reports

(2) Record Retention

b. Issuers

(1) In General

(2) Certificate Information Report

(a) Form

(b) Certificate Information

(3) Issuer Information Reports

J. Recapture of Subsidy

K. Cancellation of Indebtedness

L. Use of Qualified Mortgage Bonds in Subprime Loan Refinancing

M. Residences in Federally Declared Disasters

IV. Establishing Basis

A. Establishing Basis in Mortgaged Property

1. General Rule

2. Exceptions to the General Rule

a. Mortgage in Excess of Value of Property

b. Reduction in Basis in Potentially Abusive Situations

c. Term of Mortgage in Excess of Useful Life of Property

d. Contingent Purchase Money Obligations

e. Contingent Obligations Assumed

B. The Role of Mortgage Debt in Nontaxable Transactions

1. Incorporations Under Section 351

a. Effect on the Transferor of the Transfer of Mortgaged Property

b. Effect on Transferee of the Receipt of Mortgaged Property

c. Exceptions to the General Rule

2. Contributions of Mortgaged Property to Partnerships

a. Effect on Transferor

b. Effect on Transferee

3. Partnership Distributions of Encumbered Property

a. Nonliquidating Distributions - Effect on Transferee

b. Nonliquidating Distributions - Effect on Partnership

c. Liquidating Distributions - Effect on Partners

d. Distribution of Contributed Property

4. Tax-Free Reorganization

a. Exceptions

(1) Assumption for Tax Avoidance Purposes

(2) Liabilities in Excess of Basis

b. Basis

5. Gifts

a. Income Tax Effects to Donor

b. Basis to Donee

C. Establishing Basis for Credit Purposes

1. Mortgage Debt and the Rehabilitation Credit

a. Qualified Commercial Financing

b. Qualified Person

c. Cliff Test

d. Subsequent Increases in Credit Base

2. Mortgage Debt and the Low-Income Housing Credit

V. Income from Mortgages

A. Income from Points, Loan Fees or Commitment Fees

B. Interest Income

1. Cash Basis Mortgagee

2. Accrual Basis Mortgagee

3. Allocation of Payments

C. Prepayment Penalties

D. Mortgagee's Income from Loan Discount

1. Noncorporate Mortgagor

a. Original Discount on Loan

(1) Accrual Basis Mortgagee

(2) Cash Basis Mortgagee

b. Purchase at a Discount

c. Market Discount Bonds

2. Corporate Mortgagor

E. Mortgage or Income from Premium

1. Premiums Received from Mortgagee/Lender

2. Refund of FHA Insurance Premium

F. Interest on a Wraparound Mortgage

G. Mortgagee's Income from Collections on a Mortgage

1. Purchase Money Mortgage from Sale of Property

a. Accrual Method Taxpayer

(1) Obligations With a Determinable Fair Market Value

(2) Obligations Without a Determinable Fair Market Value

b. Cash Basis Taxpayers

(1) Obligations With a Determinable Fair Market Value

(2) Obligations Without a Determinable Fair Market Value

2. Installment Sales

VI. Losses from Mortgages

A. Background

B. At-Risk Rules

VII. Sale or Other Disposition of Mortgaged Property

A. General Rule

B. Gifts

C. Subchapter C Transactions

1. Incorporations

2. Distributions

a. Dividend Distributions

b. Liquidating Distributions

D. Like-Kind Exchanges

E. Like-Kind Exchanges - Partnership Interests

F. Subchapter K Transactions

1. Distributions of Mortgaged Property by a Partnership

a. Current Distributions

b. Liquidating Distributions

2. The Role of the Mortgage in Determining the Basis of Partnership Interests

VIII. Foreclosure of Mortgaged Property

A. Tax Consequences to Mortgagor

1. Foreclosure Sale - Mortgagor Personally Liable

a. Unpaid Interest and Taxes

b. Timing of Recognition of Gain or Loss

c. Exercise of Right of Redemption

2. Foreclosure Sale - Mortgagor Without Personal Liability

3. Conveyance to Mortgagee - Mortgagor With Personal Liability

a. Nonvendor Mortgagee

b. Purchase Money Mortgagee

4. Conveyance to Mortgagee - Mortgagor Without Personal Liability

a. Nonvendor Mortgagee

b. Purchase Money Mortgagee

5. Abandonment - Mortgagor With Personal Liability

6. Abandonment - Mortgagor Without Personal Liability

B. Tax Consequences to Mortgagee

1. Foreclosure - Mortgagor Personally Liable

a. Nonvendor Mortgagee - Third Party Sale

b. Basis in Debt

c. Amount Realized

d. When Is Bad Debt Deductible

(1) Nonbusiness Bad Debts

(2) Business Bad Debts

e. Nature of Loss

2. Voluntary or Involuntary Conveyance to Nonvendor Mortgagee

a. Basis in Debt

b. Amount Realized

c. Nature of Mortgagee's Gain or Loss

d. Time for Deducting Gain or Loss

3. Reacquisition of Property by Purchase Money Mortgagee

4. Foreclosure Sale - Purchase by Mortgagee

a. Bad Debt Deduction

b. Exchange

c. Character of Gain or Loss

5. Tax Consequences to Second Mortgagee

IX. Real Estate Mortgage Investment Conduits

A. Background

B. Discussion

Working Papers

Table of Worksheets

Worksheet 1 Foreclosure Tax Consequences to Mortgagor

Worksheet 2 Foreclosure Tax Consequences to Mortgagee

Worksheet 3 Effect of Mortgage on Property's Basis

Worksheet 4 Excerpt from IRS Pub. 17, Your Federal Income Tax (Mortgage Interest)

Worksheet 5 Excerpt from IRS Publication 544 Sales and Other Dispositions of Assets

Worksheet 6 Client Letter: Seller's Reacquisition of Mortgaged Property

Worksheet 7 Client Letter: Consequences of Foreclosure to Mortgagor

Worksheet 8 Format for 25 Certificate Issuers' Reports

Bibliography

OFFICIAL

Statutes:

Internal Revenue Code:

Treasury Rulings:

Cases:

Periodicals:

1960

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