Rev. Rul. 81-204

Are the taxpayers entitled to deduct losses from the exchange of mortgage pools under the circumstances described below?

FACTS

In 1979, X, Y, and Z, three unrelated savings and loan associations exchanged with one another a portion of their respective mortgage loan portfolios (the "mortgage pools"). The mortgage pools exchanged by X, Y, and Z consisted of single-family residential, conventional mortgages with the same contract interest rates and the same stated terms to maturity. The average remaining lives as well as the aggregate unamortized principal balances and the aggregate fair market values of the mortgages in each of the three mortgage pools exchanged were essentially the same at the time of the exchange. The underlying mortgages that made up the mortgage pools involved different mortgagors and different collateral, although the underlying nature of the collateral was the same (residential real estate) and it was all situated in the same state. For financial reporting purposes, the appropriate regulatory agency did not require X, Y, and Z to record a loss under the circumstances described herein.

For federal income tax purposes, X, Y, and Z each deducted a loss in 1979, equal to the excess of the basis in each mortgage pool transferred over the fair market value of each mortgage pool received.

LAW AND ANALYSIS

Section 1001(a) of the Internal Revenue Code provides that the gain from the sale or other disposition of property shall be the excess of the amount realized therefrom over the adjusted basis provided in section 1011 for determining gain, and the loss shall be the excess of the adjusted basis provided in such section for determining loss over the amount realized.

Section 1001(b) of the Code provides that the amount realized from the sale or other disposition of property shall be the sum of any money received plus the fair market value of the property (other than money) received.

Section 1001(c) of the Code provides that, except as otherwise provided in Subtitle A, the entire amount of the gain or loss determined under this section, on the sale or exchange of property shall be recognized.

Section 1.1001-1(a) of the Income Tax Regulations provides that the gain or loss realized from the conversion of property into cash, or from the exchange of property for other property differing materially either in kind or in extent, is treated as income or loss sustained. In other words, the exchange of property must give the taxpayer "a thing really different from what he theretofore had." Weiss v. Stearn, 265 U.S. 242, 254 (1924).

Rev. Rul. 73-558, 1973-2 C.B. 298, holds that a cash-method savings and loan association that exchanges 6-percent residential mortgages for 61/2-percent commercial mortgages having the same face and fair market value, may deduct as an ordinary loss the difference between the basis of the mortgages transferred and the fair market value of the mortgages recieved. This revenue ruling assumes that the exchange had a significant economic or business purpose.

Rev. Rul. 78-11, 1978-1 C.B. 254, holds that no gain or loss is recognized under section 1001 of the Code and the regulations thereunder by holders who exchange Farmer's Home Administration Insurance Contracts for Certificates of Beneficial Ownership, the essential terms and conditions of which (such as interest and repurchase provisions) are the same as those of the Insurance Contracts.

In this case, the mortgage pools exchanged by X, Y, and Z constituted mass or indivisible assets that averaged out the unique characteristics and risks inherent in each constituent mortgage. The "mass asset" or "individual asset" concept has long been recognized. Danville Press, Inc. v. Commissioner, 1 B.T.A. 1171 (1925); Hillside Dairy Co. v. Commissioner, No. 2395 (T.C.M. 1944); First Northwest Industries of America, Inc. v. Commissioner, 70 T.C. 817 (1978).

While the underlying mortgages that made up the mortgage pools exchanged by the savings and loan associations concerned different mortgagors and different collateral, differences in the identities of the individual obligors do not prevent the aggregation of numerous items of indebtedness into a mass or indivisible asset. United Mercantile Agencies, Inc. v. Commissioner, 23 T.C. 1105 (1955), modified as to other issues sub. nom., Drybrough v. Commissioner, 238 F.2d 735 (6th Cir. 1956), acq., 1955-2 C.B. 9; Thrifticheck Service Corp. v. Commissioner, 33 T.C. 1038 (1960), aff'd, 287 F.2d 1 (2nd Cir. 1961). Thus, the exchange of mortgage pools was an exchange of mass or indivisible assets rather than an exchange of individual mortgages.

In this context, the mortgage pools exchanged by X, Y, and Z possessed sufficient economic correspondence so that the exchanges were not of property for other property differing materially in kind or in extent. All three pools consisted of single-family residential, conventional mortgages with the same contract interest rate and the same stated terms to maturity. The average remaining lives as well as the aggregate unamortized balances and the aggregate fair market values of the mortgages in each of the three mortgage pools exchanged were essentially the same at the time of the reciprocal transfers.

In addition, facts such as those presented herein indicate that the exchange of mortgage pools had no significant economic or business purpose or utility apart from the anticipated tax consequences. It has been held that no deduction is allowable for interest paid in a transaction entered into, not in anticipation of genuine economic benefits, but merely to secure a tax benefit in the form of an interest deduction. Goldstein v. Commissioner, 44 T.C. 284 (1965), aff'd, 364 F.2d 734 (2nd Cir. 1966), certiorari denied, 385 U.S. 1005 (1967). Loss deductions are also disallowed when there is no purpose to the transaction other than to create a deduction. Brown v. United States, 396 F.2d 459 (Ct. Cl. 1968).

The present case is distinguishable on its facts from Rev. Rul. 73-558, in which there were material differences in the natures of the property covered by, and the terms of, the instruments exchanged. In addition there was no indication that the transactions there considered lacked significant economic or business purpose apart from the tax consequences.

HOLDING

The taxpayers have not met the requirements of section 1.1001-1(a) of the regulations since they have exchanged mortgage pools that do not differ materially either in kind or in extent and, therefore, pursuant to section 1001 of the Code and the regulations thereunder, no loss may be recognized on the exchange. Furthermore, deduction is also precluded because the exchange had no purpose or utility apart from the anticipated tax consequences.

EFFECT ON OTHER REVENUE RULINGS

Rev. Rul. 73-558 is distinguished.

¹ Also released in News Release IR-81-92, dated August 10, 1981.