PLR 1330008 approves a mortgage-loan sale by a governmental bond agency

Plain-English summary

The IRS rules that a state governmental housing agency's proposed sale of mortgage loans purchased with tax-exempt bond proceeds will not cause the agency or any portion of it to be treated as a taxable mortgage pool. The agency planned to use the sale proceeds primarily to redeem related bondholders and support additional mortgage lending for low and moderate income first-time homebuyers. The IRS concluded that the sale serves a governmental purpose and that the agency will continue to own the remaining interests in the assets supporting its debt obligations. The ruling is limited to the proposed sale and does not decide several other issues, including REMIC status, other taxable mortgage pool requirements, arbitrage-bond status, or all requirements for the bonds' tax exemption.

Ruling snapshot

• Question: Will the proposed sale of selected mortgage loans cause the governmental housing agency or a portion of it to be treated as a taxable mortgage pool?
• Outcome: Approved, the proposed sale will not cause TMP treatment under the stated facts.
• Key authorities: IRC §§ 7701(i), 115, 143, and 148; Treas. Reg. § 301.7701(i)-4.

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201330008 Third Party Communication: None
Release Date: 7/26/2013 Date of Communication: Not Applicable
Index Number: 7701.26-00, 115.03-00
Person To Contact:
---------------------- ---------------------, ID No. ------------------
----------------------------------- Telephone Number:
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-------------------------- Refer Reply To:
-------------------------------------- CC:FIP:B01
-------------------------------------- PLR-136029-12
Date:
April 24, 2013

Legend:

Taxpayer = ---------------------------------------------------------------------------------
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State = ---------

State Legislature = -------------------------------

State Law = --------------------------------------------------------------

Year 1 = -------

Year 2 = -------

Year 3 = -------

Year 4 = -------

Date 1 = ----------------------

Date 2 = --------------------

Date 3 = --------------------

A = --

B = ------------------
PLR-136029-12 2

Dear ----------------:

  This letter responds to a letter dated August 17, 2012, and supplemental

correspondence dated September 24, 2012, January 8, 2013, and January 16, 2013,
requesting a ruling on behalf of Taxpayer that Taxpayer’s proposed sale of certain
mortgage loans that it purchased with the proceeds of tax-exempt bonds will not cause
any portion of Taxpayer to be classified as a “taxable mortgage pool” (a “TMP”) as
defined in section 7701(i) of the Internal Revenue Code (the “Code”).

Facts:

   Taxpayer is a public and official governmental agency of State and a body

corporate and politic that was created by State Legislature in Year 1 pursuant to and in
accordance with State Law. One of the purposes of Taxpayer is to provide for the
housing needs of individuals and families of low and moderate income in State.
Taxpayer is governed by a governing board consisting of A public members, appointed
by the governor of State. Pursuant to State Law, Taxpayer may issue revenue bonds
the debt service of which is payable from, and secured by, the repayments of mortgage
loans. Such bonds must be authorized by Taxpayer’s governing board and approved
by the attorney general of State prior to issuance.

     Taxpayer has established its Single Family Mortgage Revenue Bond Program

(the “Program”) pursuant to State Law for the purpose of assisting in financing the costs
of acquisition of residences within the State by first-time homebuyers. Through the
Program, Taxpayer finances mortgage loans that meet the requirements imposed by
section 143 of the Code, including but not limited to requirements that borrowers be
first-time homebuyers and meet specified income limits and that the property financed
meet certain purchase price limits.

    Funds used by Taxpayer to acquire mortgage loans are derived principally from

its sale of bonds that meet all the requirements necessary to be “qualified mortgage
bonds” as defined in section 143 and all other requirements for interest on the bonds to
be excludable from gross income under section 103. The repayment of the tax-exempt
bonds issued by Taxpayer is secured by mortgage loans, cash, and other investments
held pursuant to a master indenture structure.

   Taxpayer entered into a Single Family Mortgage Revenue Bond Trust Indenture,

dated Date 1 (the “Master Indenture”), pursuant to which it issues tax-exempt bonds
through a trust (the “Trust”). In connection with each separate “issue” (as defined in
section 1.150-1(b) of the Income Tax Regulations) of tax-exempt bonds (each referred
to herein as an “Issue”), Taxpayer enters into one or more supplemental indentures
(each, a “Supplemental Indenture”) that supplements the Master Indenture.
PLR-136029-12 3

   Each Issue is secured by the Trust estate and held by the trustee pursuant to the

Master Indenture, as supplemented by any Supplemental Indentures (collectively, the
“Indenture”). Taxpayer is the only entity that holds an interest in the Trust estate. The
Trust estate generally includes revenues, mortgage loans, investments, and money held
in any funds established under the Indenture. However, compliance with the
requirements of section 143 and the Code is determined and monitored separately for
each Issue. This results in mortgage loans being allocated in whole or in part to the
Issue or Issues whose proceeds were used to acquire the mortgage loan. The amount
of each separate Issue issued by Taxpayer, as well as the maturities and projected
debt-service schedules with respect to debt obligations that comprise each Issue, is
determined by reference to the timing and amount of projected payments on the
mortgage loans to be acquired with proceeds of that Issue.

   Taxpayer’s ownership of mortgage loans held in the Trust estate is most often

evidenced by a pass-through certificate representing multiple, identical mortgage loans.
Mortgage loans are originated by lenders that have been approved by Taxpayer and
have agreed to originate mortgage loans in accordance with the requirements of the
Program. The originating lenders are required to sell the mortgage loans made under
the Program to the Program’s servicer. The servicer purchases qualified mortgage
loans on scheduled dates to form loan pools eligible to constitute mortgage backed,
pass-through certificates that are guaranteed as to timely payment of principal and
interest by the Government National Mortgage Association, Freddie Mac, or Fannie
Mae. The trustee for the tax-exempt bonds purchases the mortgage certificates with
proceeds of the tax-exempt bonds on behalf of Taxpayer. The mortgage certificates are
transferable.

   Under the Program, Taxpayer, through its approved lenders, is able to originate

mortgage loans to first-time homebuyers with low and moderate incomes that might not
otherwise be able to obtain affordable financing. The purposes of the Program, the
issuance of the tax-exempt bonds, and the purchase of the mortgage loans, is to
address the housing needs of the State’s low and moderate income residents.
Assuming a continuation of the market conditions on the date of issuance of an Issue of
tax-exempt bonds, Taxpayer generally expects that it will retain ownership of the
mortgage loans until those loans are fully repaid or prepaid. However, the Indenture
does permit Taxpayer to sell mortgage loans without any modification or alteration of
the tax-exempt bonds or the Indenture.

   Current market conditions have resulted in the fair market value of certain of

Taxpayer’s mortgage loans exceeding their amortized principal balances by a significant
amount. Taxpayer represents that it would benefit Taxpayer to sell certain of its
mortgage loans while these market conditions exist and that such sale would permit
Taxpayer to use the amounts realized for use in furtherance of the Program and its
stated purpose. As such, Taxpayer proposes to sell (the “Proposed Sale”) certain
PLR-136029-12 4

mortgage loans with an amortized principal balance, as of Date 2, of approximately B
(the “Selected Mortgage Loans”). The majority of each Selected Mortgage Loan is
allocated to an Issue of tax-exempt bonds issued by Taxpayer in Year 2 (“Issue 1”), but
a portion of each Selected Mortgage Loan is also allocated to an issue of tax-exempt
bonds issued by Taxpayer in Year 3 (“Issue 2”) and an issue of tax-exempt bonds
issued by Taxpayer in year 4 (“Issue 3”) (all such bond issues, collectively, “debt
obligations”).

   The tax-exempt bonds comprising Issue 1 have more than one maturity and all of

the Issue 1 bonds that remain outstanding are currently callable at the option of
Taxpayer. The tax-exempt bonds comprising Issue 2 have more than one maturity and
none of those bonds outstanding are subject to optional redemption until Date 3.
However, the Supplemental Indenture for Issue 2 does provide that the bonds of such
Issue are subject to special redemption from mortgage loan prepayments. The tax-
exempt bonds comprising Issue 3 were issued as variable-rate bonds, all of which have
a single maturity date and are subject to optional redemption on any business day.

   The buyer of the Selected Mortgage Loans in the Proposed Sale will be selected

pursuant to a competitive bid process conducted by Taxpayer’s financial advisor.
Documentation of the transfer of the Selected Mortgage Loans will be accomplished by
a transfer of the mortgage certificates evidencing ownership of the Selected Mortgage
Loans. Homeowners whose mortgage loans are included among the Selected
Mortgage Loans will be unaffected by the Proposed Sale. Additionally, the Proposed
Sale will not affect the legal rights of the holders of any tax-exempt bonds issued by
Taxpayer related to the Selected Mortgage Loans or such holders’ expectation of
repayment in full of their tax-exempt bonds; Taxpayer will remain obligated on its debt
obligations.

   Upon receipt of the proceeds of the Proposed Sale, Taxpayer intends to allocate

the proceeds to accounts established under the Supplemental Indenture for each of the
three Issues in an amount proportionate to each of the three Issues’ participation
percentage in the Selected Mortgage Loans. Taxpayer expects to use the proceeds
from the Proposed Sale allocated to each of the three Issues as follows:

  (1) The mortgage sale proceeds allocated to Issue 1 will be used to retire
  immediately (subject to any notice requirements) all bonds of Issue 1 that remain
  outstanding. Any amounts remaining after redemption of Issue 1 will be used to
  support Taxpayer’s programs, including the origination of additional mortgage
  loans to low and moderate income first-time homebuyers in furtherance of its
  governmental purpose.

  (2) The mortgage sale proceeds allocated to Issue 2 will be invested in
  nonpurpose investments the yield on which is not materially higher than the yield

PLR-136029-12 5

   on Issue 2 and used to (a) effect prepayment redemptions, and (b) to the extent
   amounts are remaining on Date 3, call a portion of Issue 2 on such date.

   (3) The mortgage sale proceeds allocated to Issue 3 will be used to retire
   immediately (subject to any notice requirements) a portion of Issue 3 and to pay
   any fees associated with a change in the notional amount of an interest rate
   swap entered into in connection with Issue 3.

   Any amounts not used to redeem bondholders will be held by the Trust.

Taxpayer represents that it will use all proceeds from the Proposed Sale in compliance
with the rules of sections 143 and 148 and any other relevant section of the Code in
order to maintain the tax-exempt status of Issues 1, 2, and 3 under section 103.

Law and Analysis:

  Section 7701(i)(1) provides that a TMP shall be treated as a separate corporation

which may not be treated as an includible corporation with any other corporation for
purposes of section 1501.

   Section 7701(i)(2)(A) provides that in general, a TMP is any entity (other than a

REMIC) if (i) substantially all of the assets of such entity consists of debt obligations (or
interests therein) and more than 50 percent of such debt obligations (or interests)
consists of real estate mortgages (or interests therein), (ii) such entity is the obligor
under debt obligations with 2 or more maturities, and (iii) under the terms of the debt
obligations referred to in clause (ii) (or underlying arrangement), payments on such debt
obligations bear a relationship to payments on the debt obligations (or interests)
referred to in clause (i).

    Section 7701(i)(2)(B) provides that any portion of an entity which meets the

definition of subparagraph (A) shall be treated as a TMP.

   Section 301.7701(i)-4(a)(1) of the Procedure and Administration Regulations (the

“Regulations”) excludes certain governmental bond programs from TMP treatment. It
provides that regardless of whether an entity satisfies any of the requirements of section
7701(i)(2)(A), an entity is not classified as a TMP if (i) the entity is a State, territory, a
possession of the United States, the District of Columbia, or any political subdivision
thereof (within the meaning of section 1.103-1(b) of this chapter), or is empowered to
issue obligations on behalf of one of the foregoing; (ii) the entity issues the debt
obligations in the performance of a governmental purpose; and (iii) the entity holds the
remaining interests in all assets that support those debt obligations until the debt
obligations issued by the entity are retired.

 Section 301.7701(i)-4(a)(2) provides that the term “governmental purpose”

means an essential governmental function within the meaning of section 115 and does
PLR-136029-12 6

not include the mere packaging of debt obligations for resale on the secondary market
even if any profits from the sale are used in the performance of an essential
governmental function.

    Taxpayer is an entity described in section 301.7701(i)-4(a)(1)(i). Thus, in order

for the Proposed Sale not to cause any portion of Taxpayer to become treated as a
TMP, it must be found that the Proposed Sale is in furtherance of Taxpayer’s
performance of a governmental purpose and that the Proposed Sale meets the
requirements of section 301.7701(i)-4(a)(1)(iii). In order to meet the requirement of
“performance of a governmental purpose,” the Proposed Sale must satisfy the
requirements under section 301.7701(i)-4(a)(2) that the Proposed Sale (1) is in
performance of an essential governmental function within the meaning of section 115,
and (2) is not the mere packaging of debt obligations for resale in the secondary market.
In order to satisfy section 301.7701(i)-(a)(1)(iii), it must be found that the Proposed Sale
does not violate the requirement that Taxpayer hold the remaining interests in all assets
that support the debt obligations until the debt obligations issued by Taxpayer are
retired.

   In providing an exclusion from gross income, section 115 requires, among other

things, that the income be derived in “the exercise of any essential governmental
function.”

    Rev. Rul. 77-261, 1977-2 C.B. 45, holds, “Income from a fund, established under

a written declaration of trust by a State, for the temporary investment of cash balances
of the State and its political subdivisions ... is excludable from gross income ....” The
ruling reasons that the “investment of positive cash balances ... in order to receive some
yield on the funds until needed to meet expenses is a necessary incident of the power
of the State or political subdivision to collect taxes and other revenues for use in
meeting governmental expenses.” In addressing the meaning of an “essential
governmental function” for purposes of section 115, the ruling states, “Congress did not
desire in any way to restrict a State's participation in enterprises that might be useful in
carrying out those projects desirable from the standpoint of the State government which,
on a broad consideration of the question, may be the function of the sovereign to
conduct.”

   In this case, the proceeds of the Proposed Sale will be used by Taxpayer

primarily to redeem holders of tax-exempt bonds issued by Taxpayer and to further
support Taxpayer’s programs, including the origination of additional mortgage loans to
low and moderate income first-time homebuyers in furtherance of its governmental
purpose. Thus, the Proposed Sale will be in furtherance of Taxpayer’s performance of
a governmental purpose and satisfies section 301.7701(i)-4(a)(ii).

 The Proposed Sale will result in a sale of mortgage loans that currently support

Taxpayer’s debt obligations; however, the Proposed Sale is a sale of unencumbered
PLR-136029-12 7

mortgage loans and, after the Proposed Sale Taxpayer will remain obligated on its debt
obligations. After the Proposed Sale, while the Selected Mortgage Loans will no longer
support any of Taxpayer’s debt obligations, amounts not used to redeem bonds will be
held in the Trust, and Taxpayer will continue to own the entire interest in the pool of
mortgages not sold pursuant to the Proposed Sale and other assets that continue to
support the debt obligations issued by Taxpayer. Thus, Taxpayer will continue to own
the remaining interest in all assets that support Taxpayer’s debt obligations, and the
Proposed Sale satisfies section 301.7701(i)-4(a)(1)(iii).

Conclusion:

   Based on the information submitted and representations made, we conclude that

the Proposed Sale will not cause Taxpayer to fail to satisfy the requirements of section
301.7701(i)-4(a)(1) of the Regulations to be exempt from the TMP rules and, thus, will
not cause Taxpayer or any portion of Taxpayer to be treated as a TMP.

    This ruling is limited to the Proposed Sale. This ruling's application is limited to

the facts, representations, Code sections, and regulations cited herein. No opinion is
expressed with regard to whether Taxpayer’s Program could meet the requirements of a
REMIC under section 860D(a), whether Taxpayer or any portion of Taxpayer would
otherwise be a TMP under section 7701(i), whether Taxpayer’s Program satisfies either
the accrual requirement or the private benefit requirement of section 115, or whether the
proposed Sale will cause the bonds financed by the Selected Mortgage Loans to be
arbitrage bonds under section 148 or cause the Issue of which such bonds are a part to
fail to meet the requirements of section 143(g).

   Except as expressly provided herein, no opinion is expressed or implied

concerning the tax consequences of any aspect of any transaction or item discussed or
referenced in this letter.

   This ruling is directed only to the taxpayer that requested it. Section 6110(k)(3)

provides that it may not be used or cited as precedent. In accordance with the
provisions of a Power of Attorney on file, we are sending a copy of this ruling letter to
your authorized representatives.
PLR-136029-12 8

  The rulings contained in this letter are based upon information and

representations submitted by the taxpayer and accompanied by a penalty of perjury
statement executed by an appropriate party. While this office has not verified any of the
material submitted in support of the request for rulings, it is subject to verification on
examination.

                                             Sincerely,


                                             Diana Imholtz
                                             Diana Imholtz
                                             Branch Chief, Branch 1
                                             (Financial Institutions & Products)