As a follow up to my earlier post, we just issued this article (pdf) about the IRS’ recent Revenue Procedure (pdf) regarding the REMIC rules. The problems inherent in last September’s REMIC Regulations have been well-covered in this blog. In short, the IRS surprised the industry by requiring a mortgage loan to pass an 80% value-to-loan test as a condition to any lien release (the same test required upon initial contribution to the REMIC). While the existing REMIC Rules could have been read to only expressly permit releases of property in connection with a qualifying defeasance, the pervasive view among issuers and their counsel for years was that certain releases (outparcels, condemnation, and partial releases upon pay-down, to name a few) were permissible so long as the release was at the option of the borrower and was subject only to certain objective criteria.

Timing is everything – and the new 80% test was instituted in the wake of the largest devaluation of commercial real estate in history. As most lenders could attest, a 125% ltv on an otherwise performing mortgage loan in 2009 was far from unheard of. This placed CMBS servicers between a rock and a hard place when the borrower had the right to sell off a property. Denying the release presumably meant facing a lawsuit from the borrower (to say nothing of claims by B note holders and mezz lenders); permitting the release resulted in a violation of the REMIC Rules, and possible liability to bondholders under the PSA.

The Rev Proc attempts to right the ship by creating two safe harbors. First, the Rev Proc allows for releases for “grandfathered transactions” – releases permitted under loan documents executed prior to December 6, 2010. The second of the safe harbors permits “qualified pay-down transactions” – releases in exchange for a principal pay-down in a qualifying amount.

The fix offered by the Rev Proc isn’t without its own set of uncertainties, however. You’ll notice a “grandfathered transaction”, by its terms, seems to include releases pursuant to contracts executed prior to this coming December. However, I don’t believe there is any consensus among tax practitioners as to whether the IRS means to indicate that existing mortgage loans could be amended in coming months to be brought into compliance (the examples provided in the Revenue Procedure unfortunately don’t offer guidance). And the definition of what constitutes a qualifying pay-down could prove very difficult to meet in some circumstances. The Rev Proc essentially requires 100% of sale or condemnation proceeds be applied toward the outstanding principal of the loan, allowing for no deduction for typical transactions costs like brokerage fees, restoration (think new curb cuts required when the city widens a road) or, ahem, legal fees. Not even reasonable legal fees.

Still, the Rev Proc goes a long way toward addressing the immediate concerns that were raised last Fall (pdf). As for it limitations – I think they will remain – no one anticipates further comment from the IRS on REMIC issues any time soon.