Rev. Rul. 70-540

Advice has been requested concerning when "points", "commitment fees", and "service fees" charged by a lending institution in connection with making real estate mortgage loans are to be included in the income of the lending institution under the circumstances described below.

The term "points" as used in this Revenue Ruling refers to a charge made by the lender (mortgagee) to the borrower (mortgagor), which is in addition to the stated annual interest rate, and is paid by the borrower to the lender as an adjustment of the stated interest to reflect the actual cost of borrowing money. The amount of the "points" charged is determined by the lender upon consideration of the factors that usually dictate an acceptable rate of interest. Thus, "points" as used in this Revenue Ruling are for the use or forbearance of money and are considered to be interest.

Situation (1). B (borrower) contracts to purchase S's (seller's) property for $30,000. B arranges to borrow $20,000 of the purchase price from X (lending institution) for which X charges B five points ($1,000). In 1970, at settlement, B pays $1,000 as points to X with funds not originally obtained from X; B executes a 25 year mortgage note payable to X in the amount of $20,000 at 8 percent interest per annum payable in monthly installments, as to both principal and interest; and X disburses $20,000 to S on behalf of B.

Section 451 of the Code states that the amount of any item of gross income shall be included in the gross income of the taxpayer for the taxable year in which received by the taxpayer, unless, under the method of accounting used in computing taxable income, such amount is to be properly accounted for in a different period.

Section 1.451-1 of the Income Tax Regulations states that under the cash receipts and disbursements method of accounting items of income are includible in gross income when actually or constructively received. Accordingly, if X uses the cash receipts and disbursements method of accounting, the $1,000 paid by B as points is includible in its income for 1970, the taxable year in which actually received.

Section 1.451-1 of the regulations also states that under the accrual method of accounting, income is includible in gross income when all the events have occurred which fix the right to receive such income and the amount thereof can be determined with reasonable accuracy. Accordingly, if X uses the accrual method of accounting, the $1,000 paid by B as points is includible in its income for the taxable year in which actually received (1970), or for the taxable year the right to receive it arises (in this situation also 1970) if earlier than the taxable year of actual receipt.

Situation (2). The facts are the same as in Situation (1), above, except X agrees to lend B the amount of the points ($1,000) in addition to the $20,000 balance of the purchase price. At settlement, B executes a mortgage note payable to X in the amount of $21,000, but X disburses only $20,000 to S on behalf of B.

In this Situation, the points represent interest which is discounted (deducted from the face amount of the loan at the time the loan is made). Thus, if X uses the cash receipts and disbursements method of accounting, X would include the $1,000 in gross income ratably as payments on the note are made. However, if X uses the accrual method of accounting, interest in the form of discount is includible as payments on the note are due, or as actually received if earlier.

Situation (3). On February 12, 1970, X agrees to make a mortgage loan to B in the amount of $20,000, effective November 12, 1970, for 25 years at a stated annual interest rate of 8 percent. X will also charge B five points when the loan is made. In consideration for X's agreement to make the loan at a specified date and at a specified rate of interest, B, on February 12, 1970, paid X $200 (commitment fee) with funds not originally obtained from X. The commitment fee is not refundable in any event and will not be applied in reduction of any other charge (e.g., points, stated interest, or other fees).

Under the above circumstances, the commitment fee is a charge for agreeing to make funds available to B rather than for the use or forbearance of money and, therefore, is not interest. See Revenue Ruling 56-136, C.B. 1956-1, 92.

If X uses the cash receipts and disbursements method of accounting, the commitment fee is includible in its income for the taxable year in which actually received (1970).

If X uses the accrual method of accounting, the commitment fee is includible in its income in the taxable year in which due or actually received, if earlier.

Situation (4). X agrees to make a mortgage loan to B in the amount of $20,000 for the purchase of a personal residence. X charges B $100 for services rendered (escrow fee, recording fee, credit inspection fee, and appraisal fee) which was required to be paid at settlement. B pays the $100 service fee to X; B executes a mortgage note payable to X in the amount of $20,000; and X disburses $20,000 to the seller on behalf of B.

The $100 service fee is includible by X in his income for the taxable year in which it was received whether X employs the cash receipts and disbursements method of accounting or the accrual method of accounting.

Situation (5). The same facts as in Situation (4) above, except that X lends B the amount ($100) charged for services. B executes a mortgage note payable to X in the amount of $20,100, and X deducts the $100 charged for services from the face amount of the loan and disburses $20,000 to the seller on behalf of B.

If X uses the cash receipts and disbursements method of accounting, the service fee is includible in the gross income of X ratably as payments are made on the note.

If X uses the accrual method of accounting, the service fee is includible in the gross income of X in the taxable year the loan is made since at that time all the events have occurred which fix the right of X to receive such income and the amount thereof is determined.