Rev. Proc. 85-42

SECTION 1. PURPOSE

The purpose of this revenue procedure is to provide issuers of `mortgage subsidy bonds,` as defined in section 103A(b)(1) of the Internal Revenue Code, with a list of the `average area purchase price` safe harbor limitations to assist the issuers in determining whether the bonds will be treated as tax-exempt obligations under section 103(a)(1) or (2).

SEC. 2. BACKGROUND

01 Section 103(a) of the Code provides that gross income does not include interest on (1) the obligations of a state, a territory, or a possession of the United States, or any political subdivision of any of the foregoing, or of the District of Columbia, and (2) qualified scholarship funding bonds.

02 Section 103A was added to the Code by the Mortgage Subsidy Bond Tax Act of 1980, Pub. L. 96-499, 1980-2 C.B. 512. Section 103A was amended by Pub. L. 96-595, 1980-2 C.B. 647, the Tax Equity and Fiscal Responsibility Act of 1982, Pub. L. 97-248, 1982-2 C.B. 462, 497, and the Tax Reform Act of 1984, Pub. L. No. 98-369, 1984-3 (Vol. 1) C.B. 1, 409. Section 103A(a) provides that, with certain exceptions, any mortgage subsidy bond will be treated as an obligation not described in section 103(a)(1) or (2). A mortgage subsidy bond is an obligation that is issued as part of an issue a significant portion of the proceeds of which is to be used directly or indirectly to provide mortgages on owner-occupied residences.

03 Section 103A(b)(2)(A) of the Code provides that any `qualified mortgage bond` will not be treated as a mortgage subsidy bond. A qualified mortgage bond is an obligation issued as part of a `qualified mortgage issue.` An issue by a state or political subdivision of a state of one or more obligations is a qualified mortgage issue if (1) all proceeds of the issue (exclusive of issuance costs and a reasonably required reserve fund) are to be used to finance owner-occupied residences, and (2) the issue meets the requirements of subsections (d), (e), (f), (g), (h), (i), and (j) of section 103A.

04 An issue of obligations issued after September 3, 1982, meets the requirements of subsection (f) of section 103A of the Code if the acquisition cost of each residence, other than a targeted area residence, to be financed with the proceeds of such issue does not exceed 110 percent of the average area purchase price applicable to such residence. In the case of a targeted area residence (defined in subsection (k)), the acquisition cost may not exceed 120 percent of the average area purchase price applicable to such residence. The average area purchase price is, with respect to any residence, the average purchase price of single-family residences in the statistical area in which sufficient statistical information for the most recent 12-month period is available. Separate determinations are made for new and existing residences, and for two-, three-, and four-family residences.

05 Section 103A(f)(2) of the Code provides that the determination of whether the acquisition cost of each residence does not exceed 110 or 120 percent of the average area purchase price for that statistical area shall be made as of the date on which the commitment to provide the financing is made or, if earlier, the date of the purchase of the residence.

06 Temporary Income Tax Regulations relating to the tax-exempt status of certain mortgage subsidy bonds under section 103A of the Code were published in the Federal Register dated July 1, 1981 (46 FR 34311), T.D. 7780, 1981-2 C.B. 25, and were amended November 10, 1981 (46 FR 55513), T.D. 7794, 1981-2 C.B. 40; May 24, 1982 (47 FR 22360), T.D. 7817, 1982-1 C.B. 23; June 8, 1982 (47 FR 24701), T.D. 7819, 1982-2 C.B. 51; June 29, 1982 (47 FR 28094), T.D. 7821, 1982-2 C.B. 52, and December 12, 1984 (49 FR 48292), T.D. 7995, 1985-4 I.R.B. 4. The temporary regulations under section 6a.103A-2(f)(5)(i) provide that an issuer may rely upon the average area purchase price safe harbor limitations published by the Department of the Treasury for the statistical area in which a residence is located. An issuer may use a limitation different than the published safe harbor limitation if the issuer has more accurate and comprehensive data. However, when computing the average area purchase price for a statistical area that is a county, the issuer ordinarily must make the computation on an individual county basis and may not combine two or more counties.

07 Section 103A(1)(4)(A) of the Code provides that a `statistical area` means (i) a standard metropolitan statistical area (SMSA) and (ii) any county that is not within an SMSA. In Press Release OMB-83-20, dated June 27, 1983, the Office of Management and Budget revised definitions of the nation's SMSAs effective June 30, 1983. The term `SMSA` was shortened to `metropolitan statistical area` (MSA). An area qualifies as an MSA if it contains a city of at least 50,000 population, or an urbanized area of at least 50,000 with a total metropolitan population of at least 100,000. If an area has more than one million population and meets certain other specified requirements, it is termed a `consolidated metropolitan statistical area` (CMSA), consisting of major components recognized as `primary metropolitan statistical areas` (PMSA).

08 The average area purchase price safe harbor limitations for the period beginning August 2, 1984, and ending August 1, 1985, were released by News Release IR-84-86 on August 2, 1984, and were published in Rev. Proc. 84-56, 1984-2 C.B. 491.

SEC. 3. APPLICATION

01 Issuers of qualified mortgage bonds may rely on the average area purchase price safe harbor limitations contained in this revenue procedure for the period beginning August 2, 1985, and ending August 1, 1986. The safe harbor limitations are estimates of the average area purchase price on which issuers may rely to satisfy the requirements of section 103A(f) of the Code. The estimates are based on information from the Federal Home Loan Bank Board's monthly survey of `Terms of Conventional Home Mortgages.` The survey contains sales price estimates for both new and existing one-family nonfarm residences. The safe harbor limitations are based on the sales price estimates for the calendar year 1984. The sales price data are adjusted for nonconventional (Federal Housing Administration (FHA) insured and Veterans Administration guaranteed) home sales. The data are presented for each MSA or PMSA for which a sufficient data sample was available. Data for the remaining areas in each state were combined to produce an estimate for `all other areas` in the state. If the data sample for a state or for `all other areas` in a state was too small, a regional estimate of the average purchase price was used. Safe harbor limitations for two-family residences are equal to the appropriate average area purchase price for single-family residences multiplied by the following adjustment factor; 1.126 for two-family residences, 1.363 for three-family residences, and 1.585 for four-family residences. These adjustment factors are similar to those used for the FHA mortgage limitations.

02 Issuers of qualified mortgage bonds that sell the obligations prior to September 1, 1985, and make commitments prior to October 31, 1985, to provide financing for owner-occupied residences may continue to rely on the average area purchase price safe harbor limitations contained in Rev. Proc. 84-56. Issuers of qualified mortgage bonds that have received a letter ruling from the Service approving an average area purchase price limitation that is higher than the safe harbor limitation in this revenue procedure may rely on the letter ruling for 1 year after the date of the letter ruling.

03 If an MSA or PMSA is contained in two or more states, the acquisition cost of a residence within that MSA or PMSA shall not exceed the safe harbor limitation provided for the MSA or PMSA, not the limitation provided for all other areas in the state.

04 The following average area purchase price safe harbor limitations have not been adjusted to reflect either the 110 percent of the average area purchase price described in section 103A(f)(1) of the Code or the 120 percent of the average area purchase price described in section 103A(f)(5).

                                           Average Area Purchase Price