IRS Will Examine REMIC Treatment

Government tax experts are reconsidering the way losses on interest-only strips are treated when investors get hit with heavy refinancings and interest payments disappear.

The current treatment has forced most individual investors away from real estate mortgage investment conduit IOs because they can only deduct losses against capital gains when the instrument is sold or terminated.

However, Treasury Department and Internal Revenue Service officials are proposing alternatives that could improve the pricing of REMIC IOs.

These proposals would allow individual investors and banks to deduct IO losses against current ordinary income when the original issue discount (OID) on the IO turns negative. Tax laws currently prohibit taking negative OID into account.

Treasury and IRS officials are "trying to resolve this problem and they are coming up with approaches that would be helpful," said Ramon Camacho, a tax partner at Shaw Pittman who specializes on cross-border securitizations.

The REMIC IO proposals are contained in an IRS notice of proposed rulemaking. The comment period ends Nov. 23.

"The solutions outlined in this notice are intended to prompt a meaningful dialogue, including suggestions regarding alternatives," acting Treasury assistant secretary Greg Jenner said. "They demonstrate our willingness to consider innovative approaches."

Mr. Camacho expects the IRS will receive some comments urging Treasury officials to go to Congress and asked for legislation that clarifies the treatment of REMIC IOs and negative OID.

However, he noted this is a very arcane issue and legislative action is unlikely.

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