Internal Revenue Service
Revenue Ruling

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 Rev. Rul. 75-99

1975-1 C.B. 197

Sec. 856

IRS Headnote

Real estate investment trust; interest on "wrap-around" mortgage loan. The portion of payments received by a real estate investment trust from a borrower on a "wrap-around" mortgage loan and paid by the trust on the senior obligation are considered made on behalf of the borrower; the portion attributable to interest on the amount of cash advanced by the trust is includible in the trust's gross income and constitutes interest for purposes of section 856(c)(2) and (3) of the Code.

Full Text

Rev. Rul. 75-99

Advice has been requested concerning the Federal income tax consequences of interest received by a real estate investment trust on a "wrap-around" loan.

An unincorporated trust, qualifying as a real estate investment trust under section 856 of the Internal Revenue Code of 1954, invested in a "wrap-around" loan. In the "wrap-around" loan in this case a party owning real estate encumbered by a senior mortgage executed a note to the trust for the total of the unpaid principal balance of the senior mortgage, plus cash advanced by the trust. The borrower also executed a mortgage to the trust encumbering the real estate described in the senior mortgage. The trust agreed to look solely to the mortgaged property for the payment of the "indebtedness" and agreed not to seek or obtain any deficiency or other money judgment in respect thereof. The borrower received from the trust that sum by which the principal amount of the "wrap-around" loan exceeded the unpaid principal balance of the senior mortgage.

The trust is not liable to the senior mortgagee on the underlying note. However, the trust agreed with the mortgagor-owner to make the periodic payments of principal and interest due on the senior obligation, provided, however, that if the mortgagor defaults on its payments on the note to the trust, the trust is relieved of its obligation to make payments on the senior mortgage. For purposes of making payments on the senior mortgage and performing other obligations required under that mortgage, the borrower appointed the trust its attorney-in-fact.

In the "wrap-around" loan in this case, the trust determined that certain property with a 300x dollar senior mortgage bearing interest at 7 percent per annum was of sufficient value to support a "wrap-around" loan to the owner in the amount of 400x dollars at 8 percent per annum. The borrower executed a note, and a mortgage securing the note, in the amount of 400x dollars at 8 percent per annum. The trust advanced 100x dollars to the borrower, the amount by which the "wrap-around" loan exceeded the principal of the senior mortgage. The borrower periodically pays to the trust an amount equal to interest at the rate of 8 percent on the 400x dollar note, together with principal thereon.

Interest is the amount one has contracted to pay for the use of borrowed money. Old Colony Railroad Co. v. Commissioner, 284 U.S. 552 (1932), XI-1 C.B. 274 (1932). As a general rule, all interest received by or credited to the taxpayer constitutes gross income under seection 61 of the Code.

Section 856(c)(2) and (3) of the Code provides that for a trust to qualify as a real estate investment trust, certain percentages of its gross income must be derived from specified sources, including interest and interest on obligations secured by mortgages on real property.

For purposes of section 856(c)(2) and (3) of the Code, the indebtedness between the trust and the borrower giving rise to an obligation to pay interest is not the total amount of the "wrap-around" loan. See Mindlin v. Davis, 74 So. 2d 789 (Fla. 1954). Although the borrower signs a note for 400x dollars, the trust actually loans the borrower 100x dollars. Payments made by the trust on the senior obligation are considered to be made on behalf of the borrower from payments received from the borrower on the 400x dollar note.

Accordingly, it is held that only the interest on 100x dollars, the amount of the cash advanced by the trust, is includible in the trust's gross income.

It is further held that the interest includible in gross income constitutes interest for purposes of section 856(c)(2) and (3) of the Code.