Fed. Home Loan Mortg. Corp. v. Comm'r of Internal Revenue
| Decision Date | 21 November 2005 |
| Docket Number | Nos. 3941–99,15626–99.,s. 3941–99 |
| Citation | 125 T.C. 248,125 T.C. No. 12 |
| Parties | FEDERAL HOME LOAN MORTGAGE CORPORATION, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
P received commitment fees for entering into prior approval purchase contracts with mortgage originators. The contracts obligated P to purchase mortgages from originators during a specified period of time pursuant to a pricing formula but did not require the originators to sell mortgages to P. The commitment fees equaled 2.0 percent of the principal amount of the mortgages. The commitment fees consisted of a 0.5–percent nonrefundable portion and a 1.5–percent refundable portion. In the taxable years 1985 through 1990, P treated the 0.5–percent nonrefundable portion of the commitment fees as premiums received for writing put options. As a result, when an originator sold a mortgage to P, P treated the 0.5–percent portion of the fee as a reduction of its purchase price and reported this amount as income over the estimated life of the mortgage. If an originator failed to sell the mortgage to P, P reported the 0.5 percent of the fee in the year in which the originator failed to exercise its right to sell the mortgage. R determined that the nonrefundable commitment fees should have been reported in the taxable year that P received the payment.
Held: In substance and form, P's prior approval purchase contracts were put options, and P properly reported the nonrefundable portion of the commitment fees as option premiums.
Robert A. Rudnick, James F. Warren, Alan J. Swirski, Richard J. Gagnon, Jr., and B. John Williams, Jr., for petitioner.
Gary D. Kallevang, for respondent.
Respondent determined deficiencies in petitioner's Federal income taxes in docket No. 3941–99 as follows:
+-----------------+
¦Year¦Deficiency ¦
+----+------------¦
¦ ¦ ¦
+----+------------¦
¦1985¦$36,623,695 ¦
+----+------------¦
¦1986¦40,111,127 ¦
+-----------------+
Petitioner claims overpayments of $9,604,085 for 1985 and $12,418,469 for 1986.
Respondent determined deficiencies in petitioner's Federal income taxes in docket No. 15626–99 as follows:
+-----------------+
¦Year¦Deficiency ¦
+----+------------¦
¦ ¦ ¦
+----+------------¦
¦1987¦$26,200,358 ¦
+----+------------¦
¦1988¦13,827,654 ¦
+----+------------¦
¦1989¦6,225,404 ¦
+----+------------¦
¦1990¦23,466,338 ¦
+-----------------+
Petitioner claims overpayments of $57,775,538 for 1987, $28,434,990 for 1988, $32,577,346 for 1989, and $19,504,333 for 1990.
In this Opinion, we decide whether certain nonrefundable commitment fees that mortgage originators paid to petitioner to enter into Conventional Multifamily Prior Approval Purchase Contracts (prior approval purchase contracts) are to be recognized when those fees are paid or should be treated as premium for “put” options, which would defer recognition until after delivery or nondelivery of the underlying mortgages.1 This issue is one of several involved in these cases.2
The parties submitted this issue fully stipulated pursuant to Rule 122. 3 The stipulations of fact and the attached exhibits are incorporated herein by this reference. At the time it filed the petitions, petitioner maintained its principal office in McLean, Virginia. At all relevant times, petitioner was a corporation managed by a board of directors.
Petitioner was chartered by Congress on July 24, 1970, by title III (Federal Home Loan Mortgage Corporation Act) of the Emergency Home Financing Act of 1970, Pub.L. 91–355, 84 Stat. 450. Petitioner was established to purchase residential mortgages and to develop and maintain a secondary market in conventional mortgages. A “conventional mortgage” is a mortgage that is not guaranteed or insured by a Federal agency. The “primary mortgage market” is composed of transactions between mortgage originators (lenders, such as savings and loan organizations) and homeowners or builders (borrowers). The “secondary market” generally consists of sales of mortgages by originators, and purchases and sales of mortgages and mortgage-related securities by institutional dealers and investors. Since its incorporation, petitioner has facilitated investment by the capital markets in single-family and multifamily residential mortgages. In the course of its business, petitioner acquires residential mortgages from loan originators. Petitioner's business is a high-volume, narrow-margin business.
A. Multifamily Mortgage Program
A multifamily mortgage loan is a loan secured on a property consisting of an apartment building with more than four residences. Petitioner offered originators two programs for selling multifamily mortgages: (1) The immediate delivery purchase program, and (2) the prior approval conventional multifamily mortgage purchase program (prior approval program).
Petitioner designed the immediate delivery purchase program to accommodate the purchase of mortgages already closed and on an originator's books at the time an originator enters into a purchase contract with petitioner. Although this program is designed for portfolio mortgages, an originator may enter into an immediate delivery purchase contract with petitioner before actually closing on the mortgage. However, if for some reason the mortgage cannot be delivered, petitioner can impose sanctions on an originator.
To participate in the immediate delivery purchase program, an originator telephones petitioner to make an offer for a purchase contract. When petitioner receives a telephone offer from an originator, that offer is “an irrevocable offer that the [originator] may not modify.” Petitioner may accept an offer within 2 business days of receiving the telephone offer. When petitioner accepts an offer, it executes two copies of the purchase contract and mails the contract to an originator. Within 24 hours of receiving the purchase contract, an originator must execute the contract and mail one copy along with a $1,500 nonrefundable application/review fee or 0.1 percent of the purchase contract, whichever is greater, to petitioner's applicable regional office. If an originator failed to acknowledge and submit a copy of a purchase contract, petitioner may disqualify or suspend an originator as an eligible seller to petitioner. After completing a documentation review, underwriting, and property inspections, if any, petitioner's applicable regional office will contact an originator. The mortgages acceptable to petitioner will be identified and purchased.
An originator must deliver the mortgages to petitioner within the 30–calendar–day commitment period. In most cases, the penalty for nondelivery is disqualification or suspension of an originator from eligibility to sell mortgages to petitioner.4
Under the immediate delivery purchase program, petitioner established its required net yield when originators offered the contracts. The required net yield is the interest rate that petitioner will receive from the mortgage it purchases from an originator. Petitioner did not charge an upfront commitment fee in its immediate delivery purchase program.
Alternatively, originators may sell multifamily mortgages to petitioner under the prior approval program, which began in 1976. Under this program, petitioner entered into contracts with originators to purchase a multifamily mortgage before the closing date of the mortgage. In general, each executed prior approval purchase contract pertained to a single mortgage, as opposed to a pool of mortgages. Petitioner's promotional pamphlets state that this program offered originators the “peace of mind” of knowing that petitioner would purchase the loan once it closed. The pamphlets also explain that once an originator entered into a prior approval purchase contract with petitioner, “delivery of the loan is still optional, so [the originators] don't have to worry if the deal hits a snag or falls through completely.”
Under the prior approval program, originators were not obligated to deliver the multifamily mortgage to petitioner. Petitioner's Sellers' & Servicers' Guide is part of the contract between an originator and petitioner. Petitioner's Sellers' & Servicers' Guide states: The Sellers' & Servicers' Guide also provides:
The optional delivery date stated in the purchase contract will be within 60 days from the date [petitioner] issues the purchase contract plus the 10–business–day period in which the [originator] may accept the purchase contract. During the 60–day period, if the [originator] intends to deliver the mortgage(s) to [petitioner], the [originator] must convert the optional delivery purchase contract to a 30–day mandatory delivery purchase contract. * * *
To receive a prior approval purchase contract from petitioner, an originator must submit a request for prior approval of a specific multifamily project. Along with the request, an originator paid a nonrefundable loan application fee of the greater of $1,500 or 0.10 percent of the original principal amount of the mortgage (but not in excess of $2,500). After completion of processing, including underwriting and property inspections, petitioner would determine if the mortgage is acceptable. Id. If acceptable, petitioner would execute a prior approval purchase contract (also called Form 6), which it mailed to an originator. An originator wishing to participate in the prior approval program would execute the Form 6, and mail or deliver it to petitioner no later than 10 business days from the date of petitioner's offer. Form 6 would set forth details of the specific...
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Federal Home Loan Mortgage Corporation v. Commissioner, Docket No. 3941-99.
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