Mortgage certificate exchange trust retains fixed investment trust status

Plain-English summary

A taxpayer proposed exchange trusts that would hold one class of mortgage-backed certificates and issue multiple classes of exchange certificates with different rights to principal and interest. Certificate holders could exchange matching interests among the underlying certificates and fixed-rate, floating-rate, inverse-floating-rate, principal-only, or interest-only exchange certificates. The IRS ruled that the exchange certificates would qualify as interests in stripped bonds or stripped coupons under section 1286, assuming one person did not hold all certificates issued by a trust. It also ruled that the exchange mechanism would not prevent each exchange trust from qualifying as a fixed investment trust. The conclusions relied on the matching economic interests, the trust's limited activities, and the absence of any power to vary its investments.

Ruling snapshot

• Question: How are the exchange certificates treated under section 1286, and does the exchange mechanism affect fixed investment trust status?
• Outcome: Approved for both requested rulings, subject to the stated representations and ownership assumption
• Key authorities: IRC §§ 1286, 7701; Treas. Reg. § 301.7701-4(c); Rev. Rul. 90-7; Rev. Rul. 91-46

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 202446009 Third Party Communication: None
Release Date: 11/15/2024 Date of Communication: Not Applicable
Index Number: 1286.00-00, 7701.03-11
Person To Contact:
-------------- --------------------------, ID No. ----------------
------------------------ -----------------
------------------------------------ Telephone Number:
---------------------------- --------------------
----------------------------- Refer Reply To:
---------------------------- CC:FIP:B02
PLR-104470-24
Date:
August 15, 2024

Legend

Taxpayer = --------------------------------------------------------------

Agencies = ------------------------------------------------------------------------------------------
---------------------------------------------------------------------------------------------------
--------
------------------------------------------------------------------------------------------
---------------------------------------------------------------------------------------------------
--------
-----------------------------

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

  This is in reply to a letter dated March 4, 2024, and subsequent correspondence,

requesting rulings that:

    (1) The Exchange Certificates (defined below) to be issued by the Exchange
        Trust (defined below) will qualify as interests in “stripped coupons” or
        “stripped bonds” within the meaning of section 1286 of the Internal Revenue
        Code, as amended (the “Code”) (assuming that all Exchange Certificates
        issued by an Exchange Trust are not held by one person); and

    (2) The Exchange Trust’s Exchange Mechanism (discussed below), including the
        ability to exchange fixed rate Certificates (defined below) for floating and
        inverse floating rate Exchange Certificates, will not cause the Exchange Trust
        to fail to be classified as a fixed investment trust under section 301.7701-4(c)
        of the Procedure and Administration Regulations.

PLR-104470-24 2

                                               FACTS

    Taxpayer structures a variety of mortgage-backed securities offerings pursuant

to multi-class mortgage-backed securities programs maintained by Agencies. In each
case, qualified mortgages1 are conveyed to a trust (referred to herein as a “REMIC
Trust” or a “Grantor Trust”, each defined below) pursuant to the terms of a trust
agreement in exchange for several classes of mortgage-backed pass-through
certificates (each such certificate (other than the residual class) is referred to herein as
a “Certificate”).

     For REMIC Trusts, each trust agreement requires that one or more Real Estate

Mortgage Investment Conduit (“REMIC”) elections be made with respect to the assets
of the trust. With respect to each REMIC, one class of certificates is designated as the
sole class of residual interest in the REMIC that is not entitled to distributions from the
REMIC (or top-level REMIC in the case of a structure with tiers of REMICs). All other
classes of certificates in each REMIC, referred to herein as “REMIC Certificates”, are
designated as classes of regular interests of the REMIC.2

     For Grantor Trust transactions, qualified mortgages are conveyed to a trust that

is or includes a grantor trust. These grantor trusts issue “Grantor Trust Certificates”
representing discrete entitlements to income and principal.3

     Taxpayer offers Certificates for sale to its customers pursuant to the terms of

an offering document. In many Agency transactions, the owner of a Certificate has the
right to deposit the Certificate in a supplemental trust (an “Exchange Trust”) in
exchange for a proportionate interest in newly issued classes of pass-through
certificates issued by the Exchange Trust (the “Exchange Certificates”) in accordance
with the Exchange Mechanism discussed below. Taxpayer will create the Exchange
Trust by contributing Certificates of a single class to the Exchange Trust in exchange
for Exchange Certificates.

The Exchange Trust

   The original assets of an Exchange Trust will be all the Certificates contributed

by Taxpayer. Subsequent contributions of Certificates to the Exchange Trust must be

1 For purposes of this letter, the term “qualified mortgages” includes certain pass-through certificates

issued by single-class pass-through trusts that are classified as trusts for federal income tax purposes as
well as REMIC regular interests or grantor trust certificates indirectly representing REMIC regular
interests. See sections 860G(a)(3); 1.860G-2(a)(5).

2 Each REMIC Certificate (other than a principal-only class) will bear interest at a fixed rate or floating rate

permitted by section 1.860G-1(a)(3) or consist of a specified portion of the interest payments on qualified
mortgages as described in section 1.860G-1(a)(2).
3 Each Grantor Trust Certificate (other than a principal-only class) will bear interest at a fixed rate or

floating rate or will consist of a specified portion (within the meaning of section 1.860G-1(a)(2)) of the
interest payments on grantor trust certificates backed by qualified mortgages.

PLR-104470-24 3

of the same class that the Exchange Trust already holds.

   All distributions made with respect to Certificates held by the Exchange Trust

are immediately distributed in respect of the Exchange Certificates. The aggregate
principal and interest entitlements on the Exchange Certificates received will equal the
aggregate principal and interest entitlements on the Certificates deposited in the
Exchange Trust.

    The sole activities of an Exchange Trust will consist of accepting deposits of

Certificates, issuing Exchange Certificates, and distributing principal and interest
received in respect of the Certificates held by the Exchange Trust to the holders of the
Exchange Certificates issued by the Exchange Trust. An Exchange Trust will not have
the power to reinvest amounts collected on the Certificates held by the Exchange
Trust. Taxpayer represents that an Exchange Trust will not be a taxable mortgage
pool and will not be an obligor of debt instruments with two or more maturities within
the meaning of sections 7701(i)(2)(A)(ii) and 301.7701(i)-1(e).

The Exchange Certificates

    The Exchange Certificates each represent the right to receive a portion of the

interest and principal distributions on the underlying Certificates; each class of
Exchange Certificates typically has rights to distributions of principal and/or interest on
the underlying Certificates that differ from those of any other class of Exchange
Certificates issued in respect of the Certificates. In each case, however, the
aggregate distributions of principal and interest on the various classes of Exchange
Certificates outstanding on any distribution date will always equal the distributions of
principal and interest on the underlying Certificates for the distribution date. Further,
the aggregate principal amount of any issued Exchange Certificates will always equal
the principal amount of the underlying Certificates.

    The Exchange Certificates will represent collectively a 100 percent beneficial

ownership interest in the Exchange Trust and will be entitled to 100 percent of all
amounts distributed in respect of the Certificates held by the Exchange Trust. They
will be issued in multiple classes that will be separately assignable.

    Exchange Certificates may provide for principal and interest, principal-only, or

interest-only entitlements. Moreover, the Exchange Certificates’ interest distributions
may be based on fixed rates, floating rates, or inverse floating rates. For interest-only
Exchange Certificates, there will be no right to receive principal, but interest payments
will be based upon a notional principal amount. Each Exchange Certificate within a
class will be entitled to a pro rata portion of payments allocated to the class. All
Exchange Certificates (other than principal-only classes) will provide for interest
distributions based on a fixed rate, a floating rate described in section 1.860G-1(a)(3),

PLR-104470-24 4

or a specified portion4 of the interest payments on the Certificates under section
1.860G-1(a)(2) as if the Exchange Trust were a REMIC.

    There exists in place a mechanism for accounting for the Exchange Certificates

as separate bonds. Exchange Certificates issued by an Exchange Trust will have the
same maturity as the underlying Certificates exchanged for them. Each class of
Exchange Certificates having a principal amount will receive on each distribution date
a pro-rata portion of the principal distributions on the underlying Certificates based on
the related principal amounts of each such class of Exchange Certificates immediately
before the distribution (i.e., no Exchange Certificates will be issued in a fast-pay/slow-
pay structure or with any time-tranching).

The Exchange Mechanism

     The Exchange Mechanism will operate in the following manner. Certificates

may be deposited in exchange for Exchange Certificates on the issue date of the
Certificates or any time thereafter. Exchange Certificates may also be deposited into
an Exchange Trust at any time in exchange for a proportionate interest in the
underlying Certificates or for different classes of Exchange Certificates, provided the
owner holds the necessary Exchange Certificates in the correct proportion to permit
the exchange.

     Each exchange, including the initial deposit of the Certificates (or portion

thereof) in exchange for the Exchange Certificates, will be for matching amounts, in
that: (1) the aggregate principal and interest entitlements on the Exchange
Certificates received will equal the aggregate principal and interest entitlements on
the Certificates or Exchange Certificates deposited in the Exchange Trust and (2) the
Exchange Certificates or Certificates received from the Exchange Trust will retain the
same tax attributes as the Certificates or Exchange Certificates deposited in the
Exchange Trust. A certificate owner will be charged a fee for each exchange,
generally based on a percentage of the principal amount of the certificates
exchanged.

     Although an Exchange Trust can accept additional deposits of Certificates over

time, the subsequent deposits of Certificates must be the same class of Certificates
as is already held by the Exchange Trust. Taxpayer represents that the exchanges
will not be taxable events under section 1001 and that they involve no change in
economic interests in underlying assets. Taxpayer further represents that the
exchanges will not cause exchanging Certificate holders or non-exchanging
Certificate holders to be entitled to a differing stream of aggregate payments from
differing obligors. Additionally, Taxpayer represents that the exchanges will have no

4 The referenced interest rate index and formula applicable to a floating or inverse floating Exchange

Certificate will not vary while the Exchange Certificate is outstanding, other than any needed changes to
the index to account for the cessation of LIBOR as an interest rate index or the substitution of
compounded average SOFR, term SOFR, or some other SOFR variant, or other index variation per each
transaction’s governing documents.

PLR-104470-24 5

effect on the rights to principal or interest of any Certificate or Exchange Certificate
holder not participating in the exchange.

                               LAW AND ANALYSIS

    Section 1286 provides rules governing the tax treatment of stripped bonds and

stripped coupons. Section 1286(a) treats a stripped bond or stripped coupon in the
hands of a purchaser as if it were a newly issued debt instrument issued at a price
equal to the purchase price. Section 1286(b) provides rules governing the person
stripping a bond, including rules for allocating basis between stripped bonds or coupons
that are sold and disposed of.

   Section 1286(e)(3) defines a “stripped coupon” as any coupon relating to a

stripped bond. A “stripped bond” is defined in section 1286(e)(2) as a bond issued at
any time with interest coupons where there is a separation in ownership between the
bond and any coupon which has not yet become payable. A “bond” is defined in section
1286(e)(1) to include any evidence of indebtedness. Section 1286(e)(5) defines a
“coupon” as any right to receive interest on a bond (whether or not evidenced by a
coupon).

   Section 860B(a) provides that in determining the tax under this chapter of any

holder of a regular interest in a REMIC, such interest (if not otherwise a debt instrument)
shall be treated as a debt instrument.

   Rev. Ruls. 84-10, 1984-1 C.B. 155; 77-349, 1977-2 C.B. 20; and 74-169, 1974-1

C.B. 147, provide that the holders of a single class of certificates in a mortgage pass-
through trust are treated as holding undivided interests in the pool of mortgages held by
the trust.

  Rev. Rul. 91-46, 1991-2 C.B. 358, provides that a mortgage is a bond for

purposes of section 1286.

    Section 301.7701-4(c) provides that an investment trust with multiple classes of

ownership interests ordinarily will be classified as a business entity under section
301.7701-2. However, an investment trust with multiple classes of ownership interests,
in which there is no power to vary the investment of the certificate holders, will be
classified as a trust if the trust is formed to facilitate direct investment in the assets of
the trust and the existence of multiple classes of ownership interests is incidental to that
purpose.

   Section 301.7701-4(c)(2), Example 4, applies this rule to a trust that holds bonds

and issues certificates evidencing interests in the bonds. Example 4 provides:

   Corporation N purchases a portfolio of bonds and transfers the bonds to a bank
   under a trust agreement. At the same time, the trustee delivers to N certificates

PLR-104470-24 6

   evidencing interests in the bonds. These certificates are sold to public investors.
   Each certificate represents the right to receive a particular payment with respect
   to a specific bond. Under section 1286, stripped coupons and stripped bonds are
   treated as separate bonds for federal income tax purposes. Although the interest
   of each certificate holder is different from that of each other certificate holder, and
   the trust thus has multiple classes of ownership, the multiple classes simply
   provide each certificate holder with a direct interest in what is treated under
   section 1286 as a separate bond. Given the similarity of the interests acquired by
   the certificate holders to the interests that could be acquired by direct investment,
   the multiple classes of trust interests merely facilitate direct investment in the
   assets held by the trust. Accordingly, the trust is classified as a trust.

   A power to contribute assets to a trust that are identical to existing assets in

exchange for new certificates identical to those already outstanding is not a power to
vary because it does not change the economic position of existing certificate holders.
Comm’r v. Chase Nat’l Bank, 122 F.2d 540 (2d Cir. 1941) (an investment trust holding
stocks was not an association where the depositor could make up additional units of the
same number and type of stock as originally deposited).

    Rev. Rul. 90-7, 1990-1 C.B. 153, provides that the redemption of pass-through

certificates issued by a fixed investment trust for a pro rata share of trust assets is not a
realization event for the certificate holder who goes from being a co-owner of all of the
trust’s assets to a sole owner of a proportionate share of the trust’s assets because the
redemption effects no material change in his position.
.
CONCLUSIONS

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

following:

   (1) The Exchange Certificates to be issued by an Exchange Trust will qualify as
       interests in stripped coupons or stripped bonds within the meaning of section
       1286 (assuming that all Exchange Certificates issued by an Exchange Trust
       are not held by one person); and

   (2) The Exchange Trust’s Exchange Mechanism, including the ability to
       exchange fixed rate REMIC Certificates or Grantor Trust Certificates for
       floating rate and inverse floating rate Exchange Certificates, will not cause the
       Exchange Trust to fail to be classified as a fixed investment trust under
       section 301.7701-4(c).

  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

PLR-104470-24 7

examination. 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 letter is directed only to the taxpayer who requested it. Section

6110(k)(3) provides that it may not be used or cited as precedent.

     In accordance with the Power of Attorney on file with this office, a copy of this

letter is being sent to your authorized representatives.

                                            Sincerely,



                                            K. Scott Brown
                                            Senior Technician Reviewer, Branch 2
                                            Office of Associate Chief Counsel
                                            (Financial Institutions & Products)

cc: ----------------------------------
----------------------------
------------------------
----------------------------

  -----------------------
  ---------------------------------------------------
  -----------------------
  ----------------------------
  ----------------------------

  ---------------
  ---------------------------------------------------
  ------------------------
  ----------------------------