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IRS Addresses Issues Relating to Payments under National Mortgage Settlement Agreement. (Parker Tax Publishing January 2014)

Guidance is provided on the tax treatment of payments received by taxpayers under the National Mortgage Settlement agreement. Rev. Rul. 2014-2.

In 2012, the U.S. government and the attorneys general of 49 states and the District of Columbia entered into a National Mortgage Settlement (NMS) agreement with five bank mortgage servicers to address mortgage loan servicing and foreclosure abuses. One component of the NMS is a Borrower Payment Fund (Fund), which the parties intend to be structured as a qualified settlement fund under Reg. Sec. 1.468B-1. The terms of the settlement agreements provide that: (1) the five mortgage servicers collectively will pay approximately $1.5 billion into the Fund; (2) the Fund will make NMS payments to certain borrowers who lost their principal residences in foreclosure on or after January 1, 2008, and on or before December 31, 2011; (3) each borrower's transaction must meet certain requirements for the borrower to receive an NMS payment; and (4) for each NMS payment, the borrower must provide certain certifications under penalties of perjury. The NMS payment for each loan is the same amount (approximately $1,400).

With respect to these payments, the following tax issues arose: (1) If a taxpayer receives a payment pursuant to the NMS due to the foreclosure of the taxpayer's principal residence, what is the proper tax characterization of the payment? (2) If the NMS payment is characterized as part of the amount realized on the foreclosure and if that characterization creates or increases a gain on the foreclosure of the principal residence, are there grounds for the taxpayer to exclude from gross income some or all of that gain? (3) If the property for which a taxpayer receives an NMS payment contained one or more additional dwelling units that were not used as the taxpayer's principal residence, how should the NMS payment be allocated between the portion of the property that the taxpayer used as a principal residence and the rest of the property? (4) If a borrower who was eligible for an NMS payment died before receiving it, what is the tax treatment of the person who receives that payment?

In Rev. Rul. 2014-02, the IRS ruled that a taxpayer who receives an NMS payment, pursuant to the NMS agreement due to the foreclosure of the taxpayer's principal residence, must include the payment in income under Code Sec. 1001 as an amount realized on the foreclosure. If a taxpayer includes an NMS payment in the amount realized and, as a result, creates or increases a gain on the foreclosure of the principal residence, the taxpayer may exclude the resulting gain from gross income to the extent permitted under Code Sec. 121.

In addition, the IRS noted, an NMS payment is intended to compensate a borrower for loss of a principal residence rather than for loss on other property. This intention is indicated by the fact that only borrowers who lost their principal residence may receive the payment. Consequently, for purposes of Code Sec. 1001, Code Sec. 121, and Reg. Sec. 1.121-1(e), if a taxpayer receives an NMS payment for loss of a multiple-unit property, a portion of which was used as the taxpayer's principal residence, then the entire NMS payment is allocable to the portion of the property used as a principal residence.

Finally, the IRS stated that a taxpayer that receives a deceased eligible borrower's NMS payment "stands in the shoes" of the borrower for purposes of determining the tax consequences of that payment. Any gain not excluded from gross income under Code Sec. 121 is income in respect of a decedent.

For a discussion of the exclusion of gain from income upon the sale of a principal residence, see Parker Tax ΒΆ77,725. (Staff Contributor Parker Tax Publishing)

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Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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