Rev. Rul. 75-192

Advice has been requested concerning the classification, for Federal income tax purposes, of an arrangement entered into by a number of persons to make a large-scale investment in individual homeowner mortgages insured or guaranteed by the Federal Housing Administration (FHA) or the Veterans Administration (VA).

Under the proposed arrangement, an investment bank will locate investors and form investment groups. These investors may include banks, trust companies, insurance companies, ordinary corporations, and individuals, each willing to commit itself to invest at least 50x dollars. Investor commitments may be satisfied only by payments in cash. When the investment bank has assembled aggregate commitments of 1,000x dollars, it will close a group. Any number of groups may be assembled. Each group will choose a trust company to act as trustee and the invested funds will be turned over to the trustee. M company, a corporation specializing in the administration of mortgages, will be retained by the trustee, under a separate agreement, to service the mortgages.

Under the agreement between M and the trustee, M will arrange to purchase existing FHA and VA mortgages of a specified quality in behalf of the trustee. M will collect the principal and interest payments on the mortgages and turn over the proceeds, less fees, to the trustee.

Under the trust agreement, the trustee will make quarterly distributions of all principal and interest payments received to each investor in proportion to his interest therein. During the period between quarterly distribution dates, the trustee is required to invest cash on hand in short-term obligations (or guaranteed by) the United States, or any agency or instrumentality thereof, and in certificates of deposit of any bank or trust company having a minimum stated surplus and capital. The trustee is permitted to invest only in obligations maturing prior to the next distribution date and is required to hold such obligations until maturity. All the proceeds received from the mortgage payments along with the interest earned on these short-term investments and deposits will be distributed to the investors quarterly. The trustee has no authority under the trust agreement to purchase new securities or mortgages, or to make any other new investments.

Section 7701(a)(3) of the Internal Revenue Code of 1954 provides, in part, that, as used in the Code, the term "corporation" includes associations.

Section 301.7701-4(c) of the Regulations on Procedure and Administration includes in the term "association" an investment trust of the type commonly known as a fixed investment trust if there is a power under the trust agreement to vary the investment of the certificate holders. However, if there is no power under the trust agreement to vary the investment, such fixed investment trust will be classified as a trust, rather than as an association taxable as a corporation.

A power to vary the investment of the certificate holders, within the meaning of section 301.7701-4(c) of the regulations, means one whereby the trustee, or some other person, has some kind of managerial power over the trusteed funds that enables him to take advantage of variations in the market to improve the investment of all the beneficiaries. See Commissioner v. North American Bond Trust, 122 F. 2d 545, 546 (2d Cir. 1941), cert. denied, 314 U.S. 701 (1942).

Although a trustee may not actually exercise all the powers and discretion granted him under the trust agreement, the parties are not at liberty to say that their purpose was other or narrower than that which they formally set forth in the instrument under which their activities were conducted. Helvering v. Coleman-Gilbert Associates, 296 U.S. 369, 374 (1935), XV-1 C.B. 261 (1936).

The short-term obligations in which the trustee may invest are subject to daily market fluctuations. In the instant case, however, the trustee is permitted to invest only in obligations that mature prior to the next distribution date and is required to hold such obligations until maturity. These requirements limit the trustee to a fixed return similar to that earned on a bank account and eliminate any opportunity to profit from market fluctuations.

Accordingly, since once M purchases the FHA and VA mortgages on behalf of the trustee neither M nor the trustee has the power under the trust agreement to vary the trust's investment after the initial purchase of the mortgages, the arrangement in question will be classified as a trust for Federal income tax purposes and not as an association taxable as a corporation.

The interest in the income from the trust have been reserved to the various investor-grantors in proportion to their respective contributions. Therefore, each investor-grantor will be treated, by reason of section 677(a) of the Code, as the owner of an aliquot portion of the trust, and all income, deductions and credits attributable to that portion are to be treated as those of the investor-grantor under section 671.

Any income taxable to the investor-grantors under section 671 of the Code should not be reported on Form 1041, but should be shown in a separate statement to be attached to the Form 1041. See section 1.671-4 of the Income Tax Regulations.