Mortgage certificate exchange trust qualifies as fixed investment trust

Plain-English summary

A mortgage-backed securities sponsor proposed exchange trusts that would hold one class of REMIC or grantor trust certificates. Investors could exchange those certificates for matching classes with fixed, floating, inverse-floating, principal-only, or interest-only payment rights, and could later reverse or recombine the exchange. The trusts would only accept identical underlying assets, distribute all received payments, and have no power to reinvest. The IRS ruled that the exchange certificates would be interests in stripped bonds or coupons under section 1286, assuming one person did not hold every class. It also ruled that the exchange mechanism would not prevent each exchange trust from qualifying as a fixed investment trust under Treasury Regulation section 301.7701-4(c).

Ruling snapshot

• Question: Will the exchange certificates qualify as stripped-bond or stripped-coupon interests, and will the exchange mechanism preserve fixed-investment-trust classification?
• Outcome: Approved on both requested rulings
• Key authorities: IRC §§ 1286 and 860B; Treas. Reg. § 301.7701-4(c)

Full text (IRS public release)

 Internal Revenue Service                                     Department of the Treasury
                                                              Washington, DC 20224

 Number: 202347001                                            Third Party Communication: None
 Release Date: 11/24/2023                                     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:B03
 ---------------------                                          PLR-101272-23
 ----------------------------------                             Date:
 FAX: ------------------------------                            August 24, 2023
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Legend

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

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

a                                 =        ---

b                                 =        ---


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

This is in reply to a letter dated December 6, 2022, and subsequent correspondence,
requesting the following rulings:

        (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 § 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 § 301.7701-4(c) of the
            income tax regulations.
PLR-101272-23                                           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 mortgages 1 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
sole 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 sole 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 intends to contribute all or a
portion of a single class of Certificates to an Exchange Trust in exchange for Exchange
Certificates.




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 §§ 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 § 1.860G-1(a)(3) or consist of a specified portion of the interest payments on qualified
mortgages as described in § 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 § 1.860G-1(a)(2)) of the interest
payments on grantor trust certificates backed by qualified mortgages.
PLR-101272-23                                3

The Exchange Trust

      The sole assets of an Exchange Trust will be all the Certificates contributed by
Taxpayer. Subsequent contributions of Certificates to the Exchange Trust must be 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 §§ 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 Certificate 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
PLR-101272-23                                        4

distributions based on a fixed rate, a floating rate described in § 1.860G-1(a)(3), or a
specified portion4 of the interest payments on the Certificates under § 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 and may occur repeatedly. 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 § 1001 and that they involve no change in economic interests
in underlying assets. Taxpayer further represents that the exchanges will not cause

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. See generally T.D. 9961 (Jan. 4, 2022) (discussing background of
LIBOR’s pending cessation and generally allowing for modifications of LIBOR-referencing instruments to
successor index such as SOFR to be treated as non-realization events for federal income tax purposes).
PLR-101272-23                                  5

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 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 § 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 § 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 § 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 § 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
PLR-101272-23                                  6

       certificates 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 the Exchange Trust will qualify as
       interests in stripped coupons or stripped bonds within the meaning of § 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 § 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
PLR-101272-23                                    7

material submitted in support of the request for rulings, it is subject to verification on
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 representative.




                                          Sincerely,


                                          __________________________
                                          Bernard J. Audet, Jr.
                                          Chief, Branch 2
                                          (Financial Institutions & Products)


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