Our nation's debt is literally indenturing our children to our international debt holders, but most Americans don't care because they are more concerned about the latest saga involving Snooki on Jersey Shore rather than what really matters, our country’s future.

Friday, October 15, 2010

WSJ- Foreclosure Mess Could Be Taxing for Mortgage Investors

More bad news on the housing front.

Foreclosure Mess Could Be Taxing for Mortgage Investors


The foreclosure mess has raised plenty of legal questions around banks' handling of defaulted mortgages. But the scandal may also create tax problems for mortgage-backed securities.

These securities were usually issued by real-estate mortgage investment conduits, or remics. They take in mortgage income and pass it through to investors without paying corporate tax.

To qualify as a Remic, assets have to be transferred or formally assigned to the vehicle usually within 90 days of its creation. The assets have to be qualifying mortgages. And they have to be secured by the property being mortgaged.

Now, flawed affidavits have led many banks to halt foreclosures; on Wednesday, 49 of 50 state attorneys general said they were launching a joint investigation into the mortgage industry. Separately, J.P. Morgan Chase in announcing third-quarter earnings on Wednesday said it was setting aside an additional $1.5 billion for potential litigation expenses. Part of this cost will likely be due to mortgage-related legal action, although Chief Executive James Dimon said it wasn't directly linked to the affidavit issue.

The affidavit imbroglio has called into question whether vehicles such as remics actually hold promissory notes—a borrower's IOU—or proof they received them. If these notes weren't properly transferred, the debts mightn't qualify for inclusion in a remic. If improperly included loans exceed 1% of a remic's assets, it could jeopardize the tax-free status.

One possible out is that tax law tends to look to the beneficial ownership of an asset, not just the paperwork. So there is a chance the Internal Revenue Service would say a remic held the burden and benefit of ownership.

But another issue may arise due to the role of Mortgage Electronic Registration Systems. This firm helped speed the packaging and sale of mortgages by acting as holder of the mortgage, which is the actual lien on a property.

While MERS would often be listed in government records as the mortgage holder, the promissory note would be passed among investors. This meant the mortgage didn't have to be re-recorded each time the note was sold.

But this suggests MERS was often the official mortgage holder, not the remic. In that case, some remic loans wouldn't have been properly secured by a property, a condition for their tax-free status. At least one class-action lawsuit has attempted to make this point.

Unfortunately, it may take some time to figure out the issues. That is due to the complexity of tax and real-estate law and the chance that outcomes could vary in different states.

Until then, mortgage investors have an uneasy wait.

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