Unrecorded Mortgages Pose Unique Issues for REMICs

County offices across the country are closed due to COVID-19, possibly precluding lenders from recording mortgages or deeds of trust on recently originated loans.  In counties where electronic recording is not available, many title insurers continue to provide title insurance during the gap period between the origination date and the recording date, allowing the continued closing and funding of mortgage transactions in areas with county closures.

Under section 860G(a)(3)(A) of the tax code, a mortgage is a “qualified mortgage” that may be included in a REMIC if it is “principally secured by an interest in real property.”  The inability to timely record raises the question of whether an unrecorded mortgage is “secured” for this purpose.  In our view, a temporary inability to record a mortgage should not preclude an otherwise qualifying mortgage from REMIC eligibility.

The REMIC regulations list mortgages, deeds of trust, and installment land contracts as means of securing an interest in real property, but do not specifically require that these instruments be recorded.  In the somewhat analogous REIT context, the IRS has treated an unrecorded mortgage as a “mortgage” under sections 856(c)(3)(B) and 856(c)(6)(B) for purposes of the REIT assets and income tests.[1]  Elsewhere, the IRS has concluded that loans made by trusts secured by unrecorded mortgages are not “adequately secured” for purposes of Treasury Regulations section 1.503(b)-1(b)(1) and section 4975(d)(1) of the Code.[2]  However, these rulings deal with mortgages that were never recorded, and one of these rulings specifically notes that the related regulations merely require a mortgage to be recorded “as soon as practicable.”  Because the intent is that any mortgage included in a REMIC would be recorded once the relevant county office is operational again, these mortgages should be treated as secured.

To be a “qualified mortgage” for a REMIC, a loan must have an LTV of 125% or less.  A loan that is not recorded risks being “primed” by a subsequent lien, and having the value of the real property securing the loan being reduced by the amount of the intervening, more senior lien.  This may cause the LTV to exceed 125%.  However, this concern should not affect the status of the loan as a “qualified mortgage.”  First, borrowers specifically covenant in their loan agreements that they will not permit the creation of any additional liens on the mortgaged property.  A violation of this covenant would result in an acceleration of the loan.  Arguably, in applying the REMIC rules, practitioners should be allowed to assume the parties will act in accordance with the terms of their agreements.  But more importantly, for REMIC purposes, a loan’s LTV generally is measured either at origination or contribution to the REMIC.  Accordingly, an erosion of the LTV as a result of a subsequent, intervening lien should not affect the status of the loan as a qualified mortgage.  

 

[1] See PLR 8611044, GCM 39484.

[2] See PLR 7930003, Rev. Rul. 85-114.

 

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