New IRS Rules: Partial Releases of CMBS Debt

IRS REMIC rules require that certain tests be met with respect to changes to individual CMBS loans for a CMBS trust to retain its tax-free status. Failing these tests can result in the pool losing its status as a REMIC, which would have horrible consequences for the trust.

In the case of partial releases, the loan servicer has to date been put in a no-win situation: the borrower had a right to a partial lien release under the loan documents; yet doing so would violate REMIC rules and the servicer's agreement in its servicing agreement with the trust to comply with REMIC rules.

The IRS' new Revenue Procedure 2010-30 gives guidance on partial release of liens and details how the IRS will provide relief for loan modifications of CMBS loans that are “grandfathered qualified mortgages” and “qualified pay-down transactions.”

The Revenue Procedure provides that a partial lien release will be a "grandfathered modification" if:

• It occurs by operation of the terms of the debt instrument, and
• The terms providing for the lien release are contained in a contract that was executed no later than December 6, 2010.

The Revenue Procedure defines a "qualified pay-down transaction" as a transaction in which a lien is released on an interest in real property and which includes a payment by the borrower resulting in a reduction in the adjusted issue price of the loan by a qualified amount.

So, if the CMBS loan expressly permits a partial release of a portion of the property upon the payment of a partial release price (all as expressly specified in the loan documents), then the CMBS loan servicer may go forward with the partial release.