A bank cannot turn time-barred over-reported section 597 income into deductible basis in mortgage servicing rights

Plain-English summary

A bank acquired a failed bank in an FDIC-assisted deal, which was a "taxable transfer" under section 597 that came with loss-share agreements counted as federal financial assistance. Because of a computation error, the bank over-reported section 597 income in several years that are now closed by the refund statute of limitations. Unable to get a refund for those closed years, the bank argued it could recover the over-reported income by treating it as extra ("phantom") tax basis in mortgage servicing rights it says it acquired, then deducting that basis as a worthless bad debt under section 166 or amortizing it under section 197. Chief Counsel advised that the bank is not entitled to those deductions. Erroneously including income does not create basis, and the over-inclusion permanently changed the bank's lifetime income (as a prior Field Attorney Advice memo already held), so it cannot be recovered through an open-year deduction that would be an end-run around the section 6511 limitations period. Separately, the servicing right is not bona fide debt (it is reasonable pay for services, not "excess servicing"), so section 166 does not apply, and the bank never showed the servicing right was a section 197 intangible it still held, so section 197 amortization is unavailable.

Ruling snapshot

• Question: Can a bank that over-reported section 597 income in now-closed years recover it by adding "phantom" basis to mortgage servicing rights and deducting it under section 166 or 197?
• Outcome: Advice: No. The over-inclusion created no recoverable basis, and neither the bad-debt nor the amortization requirements are met.
• Key authorities: IRC §§ 597, 166(a), 197, 6511; Treas. Reg. §§ 1.597-5, 1.166-1(c); Rev. Rul. 91-46; FAA 20180601F.

Full text (IRS public release)

      Office of Chief Counsel
      Internal Revenue Service
      Memorandum
      Number: 202224011
      Release Date: 6/17/2022
      CC:FIP:BR1:SMWARD                             Third Party Communication: None
      POSTU-119464-19 &                             Date of Communication: Not Applicable
      POSTU-109057-20

UILC: 597.05-01, 197.00-00, 166.00-00

date: March 10, 2022

to:   Area Counsel (Area 4)
      (Large Business & International)
      Attn: Harold Dantes-Castillo, Attorney, CC:LBI:4:MIA

from: Robert Martin
Senior Technician Reviewer, Branch 6
(Financial Institutions & Products)

subject: Recoverability of Misreported Section 597 Income from Closed Years

      This Chief Counsel Advice responds to your request for assistance. This advice may
      not be used or cited as precedent.


      LEGEND

       Taxpayer        = -----------------------------------------------
       Failed Bank     = ----------------------
       REIT            = -------------------
       Agency          = ----------------------------------------------------
       Amount 1        = ----------------------
       Amount 2        = ---------------
       Amount 3        = ------
       Amount 4        = ------------
       Amount 5        =   ------
       Amount 6        =   -----
       Amount 7        =   ---
       Year 1          =   -------

POSTU-119464-19 2

Year 2 = -------
Year 3 = -------
Year 4 = -------
Year 5 = -------

ISSUE

Whether Taxpayer, which acquired Failed Bank in Year 2 as part of a section 597
Taxable Transfer for which Taxpayer mistakenly included income in closed years due to
erroneous computations under section 1.597-5(d)(2)(iii) of the Income Tax Regulations
(the “Time-Barred Section 597 Income”), may recover the Time-Barred Section 597
Income in open tax years by increasing its adjusted basis in certain mortgage servicing
rights (the “MSR”) that Taxpayer alleges it acquired from Failed Bank, and by claiming
deductions under section 166 or 197 of the Internal Revenue Code (the “Code”) with
respect to the MSR.

CONCLUSION

Taxpayer is not entitled to the deductions claimed with respect to the MSR under
section 166(a) or section 197 because Taxpayer’s misreporting of the Time-Barred
Section 597 Income does not increase adjusted basis in the MSR. Taxpayer’s
argument repeats an argument that Taxpayer made previously (i.e., that the Time-
Barred Section 597 income created basis that Taxpayer could recover in subsequent
taxable years). The Service rejected that argument in prior advice. See Field Attorney
Advice Memorandum 20180601F (October 25, 2017) (the “FAA”).

Moreover, Taxpayer has not established that it is entitled to a deduction under section
166(a) because it has not established that the MSR constitutes bona fide “debt” that
became worthless in Year 3, nor has Taxpayer established that it is entitled to an
amortization deduction under section 197 with regard to the MSR because Taxpayer
has not established that it held the MSR as a section 197 intangible in Year 5 or any
subsequent year.

FACTS

I. The Year 2 Taxable Transfer

Taxpayer was a bank for purposes of section 581(a) for all relevant tax years in issue.
Taxpayer’s misreporting of the Time-Barred Section 597 Income has its genesis in
Taxpayer’s acquiring, in Year 2, certain assets and liabilities of Failed Bank, which was
then under the receivership of Agency. This Year 2 acquisition (hereinafter, the “Year 2
Taxable Transfer”) was expressed in a standard Purchase and Assumption Agreement
(“P&A”) that incorporated two loss-share agreements (each an “LSA” and collectively,
“LSAs”) whereby Agency agreed to reimburse Taxpayer for losses on certain “covered
assets.” The LSAs constituted “Federal Financial Assistance” under section 597(c) and
POSTU-119464-19 3

section 1.597-1(b), and the Year 2 Taxable Transfer was a “Taxable Transfer” for
purposes of section 1.597-5(a).

    A.      The Purchase and Assumption Agreement (P&A)

The P&A reflects the typical terms and conditions of a standard Agency purchase and
assumption agreement. With few exceptions, Taxpayer acquired “all right, title, and
interest of the [Agency] in and to all of the assets (real, personal, and mixed, wherever
located and however acquired) of the Failed Bank whether or not reflected on the books
of the Failed Bank as of [the Date Failed Bank was closed].” In consideration for its
acquisition of Failed Bank’s assets, Taxpayer accepted many of Failed Bank’s duties,
obligations, and liabilities, including liability for Failed Bank’s deposits in the amount of
Amount 1. Among the acquired assets were all the outstanding shares of stock in REIT,
which the P&A reflects as a subsidiary of Failed Bank. REIT in turn held loans (the
“REIT Loans”) that, Taxpayer represents, were covered under the LSA.

Taxpayer asserts that the MSR (explained in further detail below) held by Failed Bank
was among the assets that it acquired as part of the Taxable Transfer. Neither the MSR
nor the REIT Loans are mentioned expressly in the P&A.

    B.      The Loss-Share Agreements (LSAs)

As explained previously, the P&A incorporates two LSAs. One of these LSAs covered
certain “Single-Family Shared-Loss Loans” (the “Residential LSA”). The other LSA
covered Taxpayer’s assumption of certain commercial and other loans (the
“Commercial LSA”). Each LSA included materially identical terms and conditions, which
expressly supersede any conflicting terms and conditions in the P&A. Loss sharing was
limited to expressly described loans (the “LSA Loans”). Under the LSAs, Agency
generally agreed to reimburse taxpayer for Amount 3 of the first Amount 4 of losses on
LSA Loans and Amount 5 of any additional losses.

Each LSA required Taxpayer (or an entity in Taxpayer’s control) to undertake
reasonable efforts to mitigate losses on the LSA Loans. Article III of each LSA makes
Taxpayer responsible to the Agency for certain administrative duties with respect to the
LSA Loans. Specifically, section 3.1 of each LSA provides that Taxpayer “shall (and
shall cause any of its Affiliates1 to which [Taxpayer] transfers any [Shared Loss] Loans
to) manage, administer, and collect the [Shared Loss] Loans while owned by [Taxpayer]
or any Affiliate thereof during the term of this [LSA] in accordance with the rules set forth
in this Article.”

Section 3.2 of the LSA sets forth the rules for Taxpayer in performing its duties under
Article III. The Residential LSA required Taxpayer to (among other things) “manage
and administer each [identified LSA Loan] in accordance with [Taxpayer]’s usual and
1
For purposes of section 3.1 (and the LSAs generally), an “Affiliate” of Taxpayer generally includes
(among others) any “person” (defined generally as an entity or natural person) who is “directly or indirectly
controlling, or controlled by, or under direct or indirect common control with” Tax payer.
POSTU-119464-19 4

prudent business and banking practices and Customary Servicing Procedures.” The
Commercial LSA imposed a similar obligation on Taxpayer.

II. The Year 1 Mortgage Servicing Rights

Taxpayer directs our attention to a particular mortgage servicing agreement, dated as of
Year 1, between Failed Bank and REIT (the “MSR Agreement”). The MSR Agreement
provides that REIT purchased from Failed Bank, for Amount 6 and “other good and
valuable consideration,” a 100% participation interest in the benefits and obligations of
specified mortgage loans (the “MSR Loans”).

Failed Bank retained the MSR for the MSR Loans, comprising (1) a duty to service the
MSR Loans and (2) a right to a monthly fee equal to a fraction of the average
outstanding principal of the MSR Loans. The Fee was determined as the product of
(1) the average monthly principal amounts of the outstanding MSR Loans, (2) Amount 7
basis points, and (3) the number of days in the month divided by 365. Assuming a
constant outstanding principal, this fee would amount to Amount 7 basis points for each
twelve-month period (excluding leap days).

The MSR Agreement defines the MSR Loans as any “obligation of a Borrower(s) to
repay [Failed Bank] an amount evidenced by a Promissory Note(s) and other Loan
Documents.” For this purpose, the MSR Agreement defines “Borrower”, “Note” and
“Loan Documents” as the borrower, promissory note, and loan documents, respectively,
in connection with an MSR Loan.2 A schedule attached to the MSR Agreement lists the
MSR Loans as of the date of the MSR Agreement; that schedule, however, does not list
any loans. Taxpayer has not produced any other documentation expressly identifying
any MSR Loans that existed and remained outstanding as of the execution of the P&A
(or any time thereafter).

The MSR with respect to an MSR Loan terminated no later than upon the discharge of
the MSR Loan (if any), but it was also terminable at an earlier date under certain
conditions. REIT could, by notice to Failed Bank, terminate the MSR Agreement if
(among other things) Failed Bank was placed under receivership, or assigned the MSR
without REIT’s written consent.3 The MSR Agreement expressly stated that REIT’s right
to enforce these provisions (and any other provision) was not waived or otherwise
affected by REIT declining to enforce the provisions at an earlier time. As explained
above, Taxpayer maintains the MSR was among the assets that it acquired from Failed
Bank.

Taxpayer liquidated REIT in Year 3, and Taxpayer maintains that it received the REIT
Loans that REIT held at the time.

“Promissory Note” is not a defined term in the agreement.
2

3
Relatedly, Failed Bank agreed that it would not transfer its MSR without first obtaining REIT’s consent.
POSTU-119464-19 5

III. Taxpayer’s Reporting and Position(s) after Year 2 Taxable Transfer

In the taxable year it acquired Failed Bank’s assets (Year 2), and in each relevant year
thereafter, Taxpayer filed a consolidated federal income tax return on behalf of a
consolidated group of which Taxpayer is the parent. Pursuant to section 1504(b)(4),
REIT was not a member of this consolidated group, and Taxpayer otherwise treated
REIT as a separate taxable entity for purposes of applying the REIT qualification
requirements under section 856.

Taxpayer represents that it mistakenly reported the Time-Barred Section 597 Income
due to it misapplying section 597 and the accompanying regulations to the Year 2
Taxable Transfer. Taxpayer correctly determined the Year 2 Taxable Transfer was a
taxable transfer for purposes of section 597, but Taxpayer incorrectly determined that it
directly acquired the REIT Loans—instead of the REIT stock—for purposes of section

597. Taxpayer concluded that the REIT Loans were Class II assets, and mistakenly
     computed acquisition basis in those REIT Loans based on their “highest guaranteed
     value.” See Treas. Reg. § 1.597-5(c)(3)(ii). This, in turn, generated an amount of
     section 597 income (the “Section 597 Income”), which Taxpayer began including ratably
     in income over six years, i.e., each of Year 2 through Year 4. See Treas. Reg. § 1.597-
     5(d)(2)(iii) (requiring acquirers of failed bank assets to account for deemed acquisition
     basis in excess of acquirer’s cost by taking the difference into account as ordinary
     income over six years). Taxpayer, when it created the account to report the Section
     597 Income, did not implement a mechanism to subsequently amortize, depreciate,
     deduct, or otherwise recover that income.

Taxpayer acknowledges that it should have allocated the purchase price only to those
loans that it actually acquired from Failed Bank and its consolidated subsidiaries. Upon
recognizing its mistake, Taxpayer requested (and the Service agreed) that Taxpayer
was not required to report the remaining six-year portion of the Section 597 Income
attributable to open years. Taxpayer did not, however, file a timely claim for refund or
credit for the Time-Barred Section 597 Income (i.e., the Section 597 Income that was
reported on returns for Year 2 through Year 3).

Taxpayer, having failed to obtain a refund or credit on account of the Time-Barred
Section 597 Income, takes the position that such income must be allocated to tax basis
in the MSR and is recoverable in a subsequent tax year. The Service rejected a nearly
identical argument in the previously-issued FAA, which held that Taxpayer’s reporting of
the Time-Barred Section 597 Income resulted in a permanent change to Taxpayer’s
lifetime income, and thus was not a method of accounting for a material item under
Treas. Reg. § 1.446-1(e)(2)(ii)(a), and did not give rise to a section 481(a) adjustment
that would offset the Time-Barred Section 597 Income. The FAA sets forth the Service’s
conclusion as follows at p. 7:

   A review of the long-term, lifetime effect on taxable income reveals that
   the Taxpayer's erroneous inclusion of Section 597 income results in a
   change to the Taxpayer's lifetime taxable income. The Taxpayer

POSTU-119464-19 6

  acknowledges that it did not implement a mechanism to subsequently
  amortize, depreciate or deduct its phantom basis and that such basis was
  used for the sole purposes of measuring the Taxpayer's Section 597
  income amount and was ignored for all other tax purposes. Likewise, there
  is no mechanism by which the Taxpayer may deduct the cost of its
  phantom basis in an asset it did not acquire. Upon disposition of its
  banking business, the Taxpayer will not be entitled to a loss stemming
  from its erroneously included Section 597 income. [Text omitted]. The
  Taxpayer's reported Section 597 income is an error, not a material item,
  so that a section 481(a) adjustment is inappropriate.

Taxpayer is now effectively seeking reconsideration of the FAA’s conclusion that the
Time-Barred Section 597 Income resulted in a permanent difference to Taxpayer’s
income. Taxpayer previously claimed that the Time-Barred Section 597 Income gave
rise to recoverable “phantom” tax basis in the REIT Loans—a claim that the FAA
explicitly rejected under the theory that a taxpayer does not, by erroneously including
income, obtain basis in property that it did not acquire. Taxpayer now attempts to
render the FAA inapplicable by claiming that it has recoverable “phantom” basis in
property that Taxpayer in fact acquired. Namely, Taxpayer now claims the Time-Barred
Section 597 Income gives rise to “phantom” basis in the MSR, which Taxpayer may
recover under section 166(a) for Year 3 or section 197 beginning in Year 5. We
continue to agree with the conclusions set forth in the FAA that Taxpayer's erroneous
inclusion of Section 597 Income results in a change to Taxpayer's lifetime taxable
income, and is not a material item for which a method change or section 481(a)
adjustment is appropriate.

LAW AND ANALYSIS

Generally, each tax year stands on its own. Flour Mills Co. v. Commissioner, 321 U.S.
281, 286 (1944); New Colonial Ice Co. v. Helvering, 292 U.S. 435, 440 (1934). If a
taxpayer believes it has reported too much income for a prior year, it may submit a
claim for refund or credit with respect to that year. See § 6511(a); see also § 6402(a).
But Congress has limited the period of time during which such claims may be filed
(pursuant to section 6511(b)(1)), and a taxpayer cannot circumvent the period of
limitations by deducting in an open tax year a claimed over-inclusion of income from a
closed tax year. See, e.g., Commissioner v. Mnookin's Est., 184 F.2d 89, 92-93 (8th Cir.
1950) (observing that mistaken omission from income does not nullify statute of
limitations); Brady v. Commissioner, 136 T.C. 422, 428 (2011) (explaining that alleged
overpayments in a time barred year cannot be used to offset tax liability in an open
year).

  1.     No Basis Allocable to the MSR, Consistent with the Reasoning of the FAA

Taxpayer claims, as it claimed in the FAA, that the Time-Barred Section 597 Income
creates recoverable “phantom” tax basis. Taxpayer distinguishes its present claim from
that made in the FAA by now seeking to attribute the “phantom” basis to the MSR,
POSTU-119464-19 7

which (unlike the REIT Loans) Taxpayer claims it in fact acquired. We disagree. The
FAA correctly explains that the event giving rise to the Time-Barred Section 597 Income
occurred in the year of the Year 2 Taxable Transfer, and in a manner that permanently
altered Taxpayer’s lifetime income. By asserting that its basis in the MSR is increased
by the amount of the Time-Barred Section 597 Income, Taxpayer is again arguing that
there was no permanent change to Taxpayer’s lifetime income—an argument that the
Service rejected in the FAA.

Taxpayer’s repeated claims for “phantom” basis appear to reflect an unstated plea for
equity. Namely, Taxpayer appears to conclude that, if Taxpayer cannot now seek a
refund to recover the Time-Barred Section 597 Income by operation of section 6511(a),
then the equities dictate that Taxpayer should get some deduction in a later tax year.

The FAA implicitly rejected any plea for equitable basis, and we explicitly endorse that
rejection. Basis, like the period of limitations in section 6511, is a statutory construct.
See Easson v. Commissioner, 294 F.2d 653, 658 (9th Cir. 1961) (reversing the Tax
Court’s decision that a literal reading of the Code was improper if it led to the creation of
negative basis); see also United States v. Brockamp, 519 U.S. 347, 352-53 (1997)
(noting that “the nature and potential magnitude of the administrative problem” created
by making an “equitable” exception to section 6511 “suggest that Congress decided to
pay the price of occasional unfairness in individual cases (penalizing a taxpayer whose
claim is unavoidably delayed) in order to maintain a more workable tax enforcement
system”). We cannot permit Taxpayer to create a non-statutory exception to the period
of limitations through a recovery of “phantom” basis.

In any event, we do not think that our enforcing a period of limitations is inherently
inequitable. The Code’s periods of limitations prevent the government and taxpayers
alike from being subject to ever renewable litigation of aged facts and the tax items
predicated thereon. Discussing the purpose of statutes of limitations generally, the
Supreme Court has observed that “[t]he theory is that even if one has a just claim it is
unjust not to put the adversary on notice to defend within the period of limitation and
that the right to be free of stale claims in time comes to prevail over the right to
prosecute them.” Ord. of R.R. Telegraphers v. Ry. Express Agency, 321 U.S. 342, 349
(1944); see also Rothensies v. Elec. Storage Battery Co., 329 U.S. 296, 301-03 (1946)
(citing R.R. Telegraphers in the context of a tax refund suit to explain that it is the role of
Congress, not the courts, to create and limit exceptions to the statute of limitations).
Creating a non-statutory exception to section 6511 in this case would undermine the
government’s sound interest in repose in similarly situated cases. Congress apparently
thought that the benefit of any such exception could not justify its cost. See Brockamp,
519 U.S. at 352-53. We see no reason to disagree.

   2.     Taxpayer Has Not Satisfied the Requirements of Section 166 or 197

Taxpayer claims it can deduct an amount up to its basis in the MSR (adjusted upward
for the “phantom” basis) because the MSR is: (a) a bona fide debt that became
POSTU-119464-19 8

worthless for purposes of section 166(a) in Year 3 when the MSR ceased to exist after
REIT’s liquidation, or alternatively; (b) an amortizable section 197 intangible continuing
through Year 5 and after. Assuming, arguendo, the some or all of the Time-Barred
Section 597 Income could be allocated to Taxpayer’s basis in the MSR, we disagree
that Taxpayer is entitled to deductions under section 166(a) or 197.

                    a.      No Worthless Debt

Taxpayer contends that the “phantom” basis it attributes to the MSR is deductible for
Year 3 as a worthless debt deduction, because the MSR is a bona fide debt that
became worthless in Year 3. See § 166(a). We reject Taxpayer’s claim on its merits4
because (i) Taxpayer has not established that MSR (or any portion of the MSR) is a
bona fide debt, and (ii) Taxpayer has not established that the MSR became worthless in
Year 3.

                            i.      No Debt

Section 166(a) does not permit deduction for worthless property except to the extent
that the property constitutes bona fide debt. See Treas. Reg. § 1.166-1(c). A mortgage
servicing right (like the MSR) is not generally a bona fide debt to the extent it constitutes
reasonable compensation for services that the holder is required to perform. See Rev.
Rul. 91-46, 1991-2 C.B. 358, 359. However, the Service has treated a mortgage
servicing right as having a debt component (i.e., as a stripped coupon from the
underlying mortgage under section 1286) to the extent the servicer retains a right to
“excess servicing” payments that are not reasonably allocable to services. See Rev.
Rul. 91-46, 1991-2 C.B. at 359.

We see no component of the MSR servicing fee that may be treated as excess
servicing, and therefore debt. The MSR appears to impose standard servicing duties in
return for compensation equal to roughly Amount 7 basis points on outstanding
principal. This rate of compensation does not exceed the Service’s safe harbor for a
reasonable rate, see Rev. Proc. 91-50, sec. 4.02(1), 1991-2 C.B. 778, and Taxpayer
has not provided any support for treating the MSR as anything other than fully allocable
to reasonable compensation for services.5 Consequently, we conclude that no portion
of the MSR constitutes bona fide debt that could serve as the basis for Taxpayer’s claim
for a deduction under section 166.

                    ii.     No Worthlessness in Year 3

4
You have asked whether Taxpayer’s claim for refund for Year 3 on account of the bad-debt deduction is
timely with respect to Year 3. The claim itself is timely, because Taxpayer filed a return for Year 3, and
the claim was f iled within seven years from the date prescribed by law for filing the Year 3 tax return
(determined without regard to extensions). See Treas. Reg. § 301.6511(d)-1(a)(1)(ii). In any event, we
reject Taxpayer’s claim on its merits.
5
Indeed, Taxpayer did not report any amount of the servicing fees allegedly received under the MSR as a
stripped coupon under section 1286.
POSTU-119464-19 9

Assuming for purposes of discussion that Taxpayer had established that some portion
of the MSR is bona fide debt, we turn to whether section 166 permits Taxpayer to claim
a bad debt deduction for Year 3. Section 166(a) allows a deduction for a tax year only if
the debt becomes wholly or partially worthless within that tax year. Whether (and when)
a debt becomes worthless is a factual question for which Taxpayer bears the burden of
proof. See Estate of Mann v. United States, 731 F.2d 267, 275 (5th Cir. 1984); see also
Treas. Reg. § 1.166-2(a).

Taxpayer maintains that the liquidation of REIT and Taxpayer’s receipt of the MSR
Loans “extinguished” the MSR and rendered the MSR “worthless.” Even assuming that
some component of the MSR was debt, the REIT liquidation did not render that debt
worthless (for lack of collectability or otherwise). Rather, any debt component of the
MSR (i.e., the excess servicing payments) would constitute stripped coupons from the
MSR Loans, and any worthlessness regarding stripped coupons from the MSR Loans
would depend upon the performance of the MSR Loans. Taxpayer has provided no
evidence that the MSR Loans were worthless at any time during Year 3, and, likewise,
Taxpayer has provided no evidence that rights to interest coupons stripped from the
MSR Loans were worthless during Year 3.

We also question whether the MSR became worthless in a year prior to Year 3.
Taxpayer contends the MSR must have had some value during Year 3, because
Taxpayer received Amount 2 in service fees from REIT in that year. It is unclear
whether those Year 3 servicing fees were paid under the MSR. The MSR Agreement
only granted rights to Failed Bank with respect to specifically identified loans, none of
which are in fact identified in the MSR Agreement. Nor has Taxpayer provided any
other documentation to establish that any loans were subject to the MSR Agreement,
much less that any such loans remained outstanding as of Year 3. Lastly, the MSR was
apparently cancellable at REIT’s election at any time after Failed Bank entered
receivership in Year 2.6 For the foregoing reasons, we conclude that Taxpayer has not
established worthlessness of debt for Year 3 with respect to any component of the
MSR.

                   b.      No section 197 intangible as of Year 5

“A taxpayer shall be entitled to an amortization deduction with respect to any
amortizable section 197 intangible.” § 197(a). Taxpayer has not established the MSR

6
Taxpayer appears to believe the Residential LSA somehow renewed the MSR (or otherwise created a
new mortgage servicing right) because that LSA “augmented * * * several provisions” of the MSR. But
Taxpayer cites just one such “provision,” which Taxpayer describes as requiring, “as a condition to
entitlement to any loss sharing,” that Taxpayer “manage and administer each [Loan subject to loss
sharing] in accordance with [Taxpayer’s] usual and prudent business and banking practices and
Customary Servicing Procedures.” And we see no reason why a mortgage servicing right is created or
supplemented merely because Taxpayer was subjected to a mortgage servicing obligation that appears
f ully compensable by Agency agreeing to share in the losses of the serviceable loans.
POSTU-119464-19 10

constituted a section 197 intangible in the hands of Taxpayer for Year 5 or after.

Mortgage servicing rights may not constitute a section 197 intangible unless they are
“acquired in a transaction (or series of related transactions) involving the acquisition of
assets (other than [mortgage servicing rights]) constituting a trade or business or
substantial portion thereof.” § 197(e)(6). Generally, all mortgage servicing rights
acquired in the same transaction or in a series of related transactions are treated as a
single asset (the pool) for purposes of determining deductions for depreciation and gain
or loss on disposition. Treas. Reg. § 1.167(a)–14(d)(2)(i).7

We question Taxpayer’s section 197 claim for essentially the same reasons that we
question Taxpayer’s claim that the MSR first became worthless in Year 3. See supra
Part 2.a.ii. Taxpayer has not shown the MSR was an outstanding asset as of the Year
2 Taxable Transfer, much less at any later time. See id. Nor does Taxpayer contend
that the MSR was treated as part of a pool of mortgage servicing rights acquired in the
Year 2 Taxable Transfer, much less that such pool remained outstanding as of Year 5.
Cf. Treas. Reg. § 1.167(a)–14(d)(2)(i).8

CASE DEVELOPMENT, HAZARDS AND OTHER CONSIDERATIONS

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This writing may contain privileged information. Any unauthorized disclosure of this
writing may undermine our ability to protect the privileged information. If disclosure is
determined to be necessary, please contact this office for our views.

Please call (202) 317-4451 if you have any further questions.

                                         By: _____________________________
                                             Robert A. Martin
                                             Senior Technician Reviewer, Branch 6
                                             (Financial Institutions & Products)

7
“If the taxpayer establishes multiple accounts within a pool at the time of its acquisition, gain or l oss is
recognized on the sale or exchange of all mortgage servicing rights within any such account. ” Treas. Reg.
§ 1.167(a)–14(d)(2)(ii).
8
Taxpayer has not proposed (much less established) that its disposition of the MSR (assuming Taxpayer
acquired it) is disregarded in favor of an increase in other adjusted bases that are amortizable and
deductible under section 197 for Year 14 or after. Cf. § 197(f)(1)(A). Indeed, Taxpayer has not
established any basis in the MSR.
POSTU-119464-19 11

cc: Deputy Division Counsel
(Large Business & International)
Attn: Robin Greenhouse