IRS Tax: IRS issues guidance on modifications to commercial mortgage loans

The Internal Revenue Service on September 15 issued anxiously awaited guidance on modifications to commercial mortgage loans held by real estate mortgage investment conduits (REMICs), including final regulations on permissible modifications, a revenue ruling on modifications to loans at risk of default, and a notice on modifications to loans held by investment trusts.


Final regulations on permissible modifications

Final regulations (T.D. 9463) expand the list of permissible modifications to commercial mortgage loans held by REMICs so that changes in collateral, guarantees, and credit enhancement of an obligation and changes to the recourse nature of an obligation will not cause the obligation to fail to be a qualified mortgage. These changes are permitted as long as the obligation continues to be principally secured by an interest in real property.

Significantly, the final regulations clarify that a lien release that is occasioned by a default or a reasonably foreseeable default will not disqualify a mortgage as long as the principally-secured test is satisfied. The final regulations allow servicers some flexibility in satisfying the principally-secured test. They provide the test will be satisfied if the servicer reasonably believes that the modified mortgage loan satisfies the 80-percent test at the time of the modification. The reasonable belief must be based on any commercially reasonable valuation method including those provided in the regulations. The regulations are effective September 16, 2009.


Modifications to loans at risk of default

Rev. Proc. 2009-45 describes the conditions under which modifications to the terms of certain commercial mortgage loans that are at risk of default will not cause the Service to challenge the tax status of securitization vehicles that hold the loans or to assert that the modifications give rise to prohibited transactions. Among other requirements, the revenue procedure provides that eligible modifications would include those where, based on all the facts and circumstances, the holder or servicer reasonably believes there is a significant risk of default of the pre-modification loan upon maturity of the loan or at an earlier date and also reasonably believes that the modified loan presents a substantially reduced risk of default, as compared with the pre-modification loan.

For similar guidance with respect to modification of certain residential mortgage loans, see Rev. Procs. 2007-72, 2008-28, and 2008-47.


Modifications to loans held by investment trusts

Finally, Notice 2009-79 solicits comments on whether the regulations should permit modifications to be made to commercial mortgage loans held by investment trusts and the extent to which such changes are consistent with Service's position on fixed investment trusts.