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Retained or residual interests in securitizations represents the mortgage banker s right to receive cash ows from the mortgage assets that are not required to: (1) pay certi cate holders their contractual amounts of principal and interest, (2) fund reserve accounts stipulated in the securitization structure, (3) pay expenses of the securitization, and (4) make any other payments stipulated in the securitization Such retained interests must be evaluated for impairment pursuant to EITF No 99-20, Recognition of Interest Income and Impairment on Purchased and Retained Bene cial Interests in Securitized Financial Assets (g) TAXATION Mortgage banks are subject to federal income taxes and certain state and local taxes The taxation of mortgage banks is extremely complex; therefore, a discussion in depth is beyond the scope of this book However, certain signi cant factors of mortgage banking taxation are discussed below (i) Mortgage Servicing Rights The tax treatment of servicing rights changed substantially in 1991 for both mortgage loan originators and subsequent purchasers of mortgage loans Under Rev Rule 91-46, a lender selling mortgages while retaining the right to service the loans for an amount in excess of reasonable compensation, is deemed to have two types of income resulting from a servicing contract: normal (ie, reasonable) or excess servicing compensation Generally, taxable income for normal servicing is recognized as received (ie, as asset is not created at the time of loan sale as it is for book purposes), thus a book to tax difference will exist upon sale of the underlying loan to a third party Income deemed received for excess servicing is included in income on a yield-to-maturity basis The Treasury has provided safe harbor amounts providing guidance to what is deemed normal or reasonable compensation Normal compensation is for the performance of general mortgage services, including a contract requiring the servicer to collect the periodic mortgage payments from the mortgagors and remit these payments to the owner of the mortgages The safe harbors establish that compensation for the performance of all services under the mortgage servicing contracts should generally be between 25 and 44 basis points, annually, determined more speci cally on the type of residential loans Guidance as to reasonable compensation on commercial mortgages has not been provided; it is the taxpayer s responsibility to establish and support what is reasonable compensation for the services it performs Excess servicing is those funds received in excess of reasonable compensation, thus the term excess servicing rights Excess servicing rights have been determined to represent a stripped coupon, while the underlying mortgage that was sold represents a stripped bond The fair value of the stripped coupon (ie, servicing right) is determined based on the relevant facts and circumstances The mortgage servicing business is fueled by volume, thus it is common for a mortgage bank to be an originator of mortgage loans, a purchaser of mortgage loans, and a purchaser of servicing If both the loan and the servicing right are purchased, and the loan is subsequently sold with servicing retained, tax treatment will generally follow the same treatment as if the seller originated the mortgage loan This treatment is signi cantly different compared to the purchase of only mortgage servicing rights Purchased mortgage servicing rights (PMSRs) are amortized over 15 years when acquired in connection with a trade or business or over 108 months when a servicing portfolio is separately acquired Certain restrictions prevent the recognition of loss in value of a servicing portfolio unless the entire portfolio or individually identi ed loans within a pool of serviced loans are disposed of, thus taxpayers may have dif culty realizing the loss in value of a servicing portfolio that has signi cant prepayments until all the underlying mortgages have been paid down (ii) Mark-to-Market Contrary to normal realization-based tax accounting principles, IRC Section 475 requires dealers in securities to recognize gain or loss through marking-to-market their securities holdings, unless such securities are validly identi ed by the taxpayer as excepted from the provisions As used in this context, the terms dealer and securities have very broad application Virtually all nancial institutions are considered dealers in securities for mark-to-market purposes, though
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