CMBS Loans: IRS Corrects Mistake & Recognizes Partial Release Provisions
Recently the IRS corrected a mistake inadvertently created by it in September 2009, when it made changes to the REMIC rules governing changes to CMBS loans. One result of the 2009 change was that partial releases, expressly contemplated in the CMBS loan document, must pass the “principally secured by real estate” test for qualified mortgages at the time of the partial release (see Section 860G(a)(3)(A) of the Internal Revenue Code and Section 1.860G-2(a)(8) of the Income Tax Regulations).
Failing this test could result in the CMBS pool losing its status as a REMIC, which would have horrible consequences to the tax-free status of the CMBS trust.
Thus, the loan servicer was placed in a no-win situation: the borrower had a right to a partial lien release under the loan documents; yet doing so would violate REMIC rules and the servicer's agreement (in the servicing agreement) to comply with REMIC rules. (Loss of tax-free status for the trust = heads roll at the loan servicer).
The borrower, of course, was not interested in the loan servicer's problem; it simply wanted the benefit of the bargain (see CMBS gripes of borrowers). (Sounds like a personal problem of the loan servicer.)
The IRS' new Revenue Procedure 2010-30 gives guidance on this problem and details how the IRS will provide relief for loan modifications of CMBS loans that are “grandfathered qualified mortgages” and “qualified pay-down transactions.”
The Revenue Procedure provides that a partial lien release will be a "grandfathered modification" if:
- it occurs by operation of the terms of the debt instrument, and
- the terms providing for the lien release are contained in a contract that was executed no later than December 6, 2010.
The Revenue Procedure defines a "qualified pay-down transaction" as a transaction in which a lien is released on an interest in real property and which includes a payment by the borrower resulting in a reduction in the adjusted issue price of the loan by a qualified amount.
So, if the CMBS loan expressly permits a partial release of a portion of the property upon the payment of a partial release price (all as expressly specified in the loan documents), then the CMBS loan servicer may go forward with the partial release.
This is good news.
Nice to have good news.
It is interesting that the IRS does not address this request: dropping the requirement for a retesting of collateral released when a loan is in default. This request was made by industry organizations in order to give CMBS special servicers additional flexibility as they deal with defaulted CMBS loans.
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